Sunday, September 20, 2015

The Importance of Emergency Fund

Why do we need to understand the importance of EMERGENCY FUND before proceeding to investment?

Perhaps, one of the reason is to avoid touching our investment intended for long term. 

Consider this, let's assume we manage to make our cash flow positive and able to manage our debt but then decided to jump right away to long investing without really understanding the importance of EMERGENCY FUND. And, let's assume that at this time, we decided and make it a goal to retire with sufficient savings to cover for our own expenses at the age of 65. 

During the 12 years of working and investing we were satisfied with our investments earning. Assuming that our investment from PHP100,000 at an average of 12% compound interest ballooned to 400,000. However, about this time an unexpected emergency happen, perhaps we lost our job or one of family or ourselves got sick. 

Where do you think is obvious choice to fund our emergency? Say, we only needed PHP300,000 to settle our emergency and decided to get that from our investment earning. We didn't lose, right? Since we still manage to retain our capital. 

Yes, indeed our capital will be retained at that point in time but, our biggest lose will be the 12 years of letting our money compound for itself. At that point in time, we just LOSE 12 YEARS towards our retirement age goal.

Another obvious importance of emergency fund is that it will serve as our buffer fund whenever we encounter an unexpected circumstance in life such as temporal lose of Job or minor medical needs that requires immediate liquidation of cash. This is why it is advise to just place this fund in a savings account for easy liquidation, we just need around 3-6 months of our expenses to be place in a savings account for our buffer fund. Now, for major emergencies this fund may not be enough especially like hospitalisation need or expenses, we certainly don't want to top up this fund using credit to settle such emergencies. It would be wise therefore for us to get a medical insurance, this will back up our emergency fund or, perhaps our emergency fund will not be touch as usually, if we know how to pick a medical insurance properly, it would be enough to cover such emergencies. Once the 3-6 months worth of expenses has been save in a savings account, the rest should be diversified to other investment vehicle like say mutual fund, property, insurance, stocks and business.

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