In recent times attention has been turned to emergency savings funds and the importance of building them. But there still exists some confusion about what an emergency savings fund is, exactly, and what it should be used for. On this day that we celebrate mothers, who are often the chief financial officers of Jamaican households, we will attempt to answer some of the questions regarding emergency savings that will put you firmly on the path to financial empowerment.

Why is an emergency savings fund (ESF) necessary?

The term “emergency savings” is exactly what the name implies: funds that are drawn upon in an emergency. In practical terms, it is the savings that would have served people who suddenly lost their jobs at the onset of the novel coronavirus pandemic. It’s savings that provide a cushion when the unexpected happens, so that you don’t immediately start using a credit card or borrowing from people and hence racking up expense when life throws you a curve ball.

Is it different from regular savings?

An ESF is absolutely separate and apart from a regular savings account. Both are savings funds that help you to make plans for the future, but their usage is different. An ESF is used to offset high expenses that arise from an unforeseen situation that can potentially deal a devastating blow to your way of life if you’re unprepared. On the other hand, a savings account, while also a rainy-day fund, is for lower expenses that are not earth-shattering. For example, a savings account would be for replacing your stove. It would not necessitate you touching your emergency fund because it’s not life and death.

When should I use it?

These funds are not only for use in the event of sudden job loss or a cut in income; they are also savings for other unpredictable incidentals like major emergency work on your home (eg roof fixing), and even periodic expected expenses (like back-to-school, annual car registration and insurance, property and income taxes) which can often sneak upon you. Or, depending on your social milieu, let’s say the beloved pet whom you and your children consider to be family, needs a life-saving surgery.

It is not for non-essential spending, so, no, you absolutely may not take money out of it because your favourite retailer is having a sale, or for taking a vacation, or for financing a friend or family member’s emergency. Nor is it to be used as a nest egg for retirement, further education, buying a car or upgrading your phone. If the thing you are considering spending your ESF on is not an emergency, you should NOT use these funds.

How much should be in it?

Of course, there are no hard-and-fast rules; it depends on your life circumstances and how much you make. In the past, the rule of thumb was to set aside the equivalent of three to six months’ expenses. Now, after the reality of the ongoing pandemic, financial advisors are more inclined to say a year, especially if children or a partner are involved. Note that it isn’t a year’s salary; it is essential expenses. So, what are your essential monthly expenses? Rent, mortgage and maintenance, utilities, groceries, petrol, loan repayment, medication. Calculate these costs and then multiply them by three, six or 12, to see what your ESF should vaguely look like. Also, if you are in a multiple-income living situation, work out how much each person can comfortably contribute and allow for this in your monthly budget.

Should An ESF consist only of cash?

Ideally, cash at hand is best. But that can be extended to assets that are liquid, as well. So if you have assets that can be quickly swapped out for cash, this can work too.

Where should I put my emergency savings?

Whatever you do, do not keep this fund in a drawer or a cupboard at home! You want it close at hand but not so close that you can easily dip into it. Besides, you want these savings to compound and earn interest in the meantime. Best to put it into a high-yield savings account taken out specifically for emergencies. A money market account is also a good place to park these funds, as these accounts tend to give higher yields over time than a savings account, although they can be slightly riskier. Another place to put these savings is in certificates of deposit (CDs). This one is kind of tricky because CDs are essentially illiquid, meaning the funds are locked into a fixed time frame, and removing them before the time can result in you being penalised. The interest rate on CDs can be attractive, but holding cash there can incur significant opportunity cost.

Bottom line

Start building an emergency savings fund now, if you haven’t already done so. And if you already have one but put funds in it ad hoc, or if you raid it for random and non-essential spending, start rebuilding it by including payments to it as part of your monthly budget. As with money decisions you’re unsure of, do consult a financial advisor.

Remember, the money you save today can go a long way towards meeting your family’s financial needs whenever the next emergency crops up.