How are those New Year's resolutions going? Or have they already gone?
Almost a quarter of the year has flown by already, and I thought I'd revisit what I'd like to achieve over the next few months, and whether I am at all on track. My new year's personal finance resolution was (is - gulp) to build up my emergency fund. And, yes, this is still an ongoing project.
Yes, yes, I know - how on Earth could I have started www.cashy.me - which is all about financial empowerment - when I don't have my own, very basic bases covered? Well, that's the whole point: we can all do with a bit of help when it comes to managing our money. (Plus I have cashy.me to feed.) Anyway, I digress …
Having mentioned emergency funds to various people in the course of work and life, I've been quite amazed at their definitions.
Intelligent people who are successful, and who have many of their money issues covered, appear to think that an emergency fund is the same as savings. Well, in a word, no. An emergency fund is precisely what it says on the tin: cash that can be made available at short notice to cover unforeseen events. And in today's world, I'd say this is doubly important - and guess what, things do happen - any time, any place. I'm sure you have people in your own circles who have lost jobs, are unable to work for a prolonged time for some reason, or whose source of support (say, a spouse) is suddenly no longer there.
Someone I know - with a head of silver hair - told me he'd recently spent his "fund" on property in Thailand … I can only hope that his big splurge fits in with a retirement strategy. More likely it's a case of him building up cash, then using it for some major purchase, rather than keeping it aside.
Another, extremely savvy person said she had a "blow it" fund that was there to allow her freedom of choice. How very wonderful and cashy. But that fund exists to enable her to one day travel, or write a book, or simply have the option of taking time out. It's super and admirable that she's done this - and has a wad of cash many would give an eye-tooth for - but it isn't quite an emergency fund.
I'm afraid that laying down our financial foundations can appear so very boring, but it's oh so very important. My definition of an emergency fund is enough cash at hand to see me through nine months at least of not earning a single penny. So, sure, you could argue that my friend's "blow it" fund fits in with that. But if she was to go off and travel, or pen that novel, she'd be depleting her emergency fund - and when it came time to earn again, who's to say she can walk into paid employment? In fact, that's exactly when the emergency fund should kick in; after she's done her "blow it" stint, to carry her through looking for the right kind of job. And when she succeeds, she should build her emergency fund up again straight away.
So let's figure this out. What do I need to take into account?
Well, my list of "must have covered" includes:
Food, accommodation, petrol, car payments, car insurance, school fees, clothes, after-school activities, a bit of a social life, covering existing policies including health insurance, life insurance, education fund, pension fund. Yours might be different. You could have a mortgage on a property somewhere that you need to cover every month, or extra savings plans, or (I hope not) monthly payments to clear a debt, or perhaps you contribute to your parents' financial outgoings.
So, really, the only way to do it is this.
Look at your whole life. Which annual policies and commitments do you have? Put them down on a piece of paper and divide them by 12.
Then, for at least three months I'd say, keep every single receipt for each transaction you make. Stick them into an envelope that you can carry with you all the time - and add it all up. I say three months because you might have a big shop at random times. Plus I think it will give a much more accurate - and realistic (because this is what you're after) account of how much you spend and where it goes.
Average out your three-month spending. Add your average monthly spending to your monthly commitments from step one, and there you have it: one month's expenses. Now you need to save the equivalent of nine months' outgoings and stick it into your emergency fund.
I bet you'll be a tad taken aback, by the way. It will most likely be significantly higher than any figure you pluck out of the air right now. Those outlays really do add up.
With knowledge comes responsibility. We all need to build up a cash fund that will see us through any unforeseen rough times. And if you're lucky enough not to experience any, your cash can be earning for you. More on that another time.
Nima Abu-Wardeh is the founder of the personal finance website www.cashy.me