Coronavirus impact: Why you should have an emergency fund in place

With the Coronavirus outbreak disrupting businesses, it has thrown several UAE residents’ life into disarray. Several families who live from pay cheque to pay cheque are increasingly feeling the pinch, without a safety buffer in place. Now, more than ever before, it is important to start setting aside money in an emergency fund, which you can dip into during times of economic uncertainty.

It would be prudent to consider US personal finance lawyer Elizabeth Warren’s 50/30/20 rule. The tactic teaches people how to allocate their money towards paying various expenses by breaking spending into three categories: needs, wants and savings.

The 50/30/20 rule

The first category must go towards paying essential bills such as rent, mortgage payments, insurance, utilities, credit card dues, groceries, transportation fares, healthcare, etc. Don’t compromise here as this happens to be one of the most essential categories of expenses as it directly affects individual’s day-to-day living. But these bills must not exceed the 50 per cent mark.

The second category of wants comprises all non-essential spending such as shopping, dining out, vacation and luxury outings. This category also includes TV and gym subscriptions, phone and car upgrades and non-essential purchases, etc. The third category of savings is essentially the money that should be allocated towards savings, or money put away as part of an emergency fund.

For instance, for a family who earns Dh15,000 per month, using this method they would be required to save at least Dh3,000 till they reach the higher threshold slab of Dh7,500 (needs + savings combined).

After determining how much money you make each month, if you find that you are having difficulty affording rent, for instance, it might indicate that you need to cut back in the wants category, by either cancelling a gym membership or streaming subscription.

Emergency situations

Emergency situations could manifest in various forms. It could be an unexpected job loss, a large unplanned non-covered medical emergency, a sudden change in your spouse’s financial situation, unexpected travel for a very critical situation, identity theft wherein your credentials and money are stolen, or natural disasters like pandemics, earthquakes, etc.

While a savings account is primarily meant to cover long-term or even medium-term requirements for one’s family and other personal expenses, the purpose of having an emergency account is different and critical in the current world scenario

- Vijay Valecha, Chief Investment Officer, Century Financial

“There is often a tendency to consider normal savings and emergency account as one and the same. It should, however, be noted that while a savings account is primarily meant to cover long-term or even medium-term requirements for one’s family and other personal expenses, the purpose of having an emergency account is altogether different and critical in the current world scenario,” said Vijay Valecha, Chief Investment Officer, Century Financial.

Personal finance experts recommend that as a rule of thumb, a person needs to have 3 to 6 months’ worth of living expenses in his/her personal contingency fund. This should always be kept in a savings account as it would benefit the individual with an interest rate component.

“Depending upon the individual’s monthly salary and job stability, an appropriate choice regarding 3 or 6 months can be made. The basic idea would be to always build up reserves in high-income months and contribute consistently thereafter even in low-income months,” Valecha added.

Need for a safety buffer

Munib Khan, a UAE-based investor, also stressed the importance of having a safety buffer in place to cushion the impact of unforeseen circumstances.

“Ensure that you have at least six months’ worth of expenses in cash [held in a savings account where you are earning interest] that can be accessed when there is an emergency such as losing your job rather than dipping into your investment portfolio. You don’t want to be cashing out from your equities and/or bond exchange-traded funds during a downturn such as now,” Khan observed.

Job losses are likely across entire global economy, with no sector escaping the impact of the coronavirus. Under such circumstances, it is always better to prepare for future unexpected contingencies so that you don’t risk missing important payments such as a mortgage, rent, car loan or your child’s education fees.

“Many recommend having around Dh3,600 in a current account for situations like your car breaking down or a family member unexpectedly going into hospital. Once you have built up your Dh3,600 emergency fund, the next step is to have between three to six months of expenses in cash. This allows you to live for an extended period of time without a job,” said Zach Holz, who runs a personal finance blog called The Happiest Teacher.

Individuals should plan for a possible scenario where their expenses may exceed the normally allocated budget. This requires maintaining a sufficient buffer in order to avoid getting into a debt trap. It would be best to always keep some amount of cash in hand or at home for want of immediate liquidity.

Create a crisis budget

Personal finance experts said one of the first steps in creating an emergency fund is to allocate a crisis budget.

“For instance, an individual who feels his job is under threat may need to first calculate essential expenses for the next 3 to 6 months like food, rent and utilities in order to have the required income during his lay-off period. This can be achieved by saving from current salary or by blocking amounts from regular savings account,” recommended Valecha.

The next step is to reduce expenditure and cut down on all non-discretionary purchases. For instance, you can do away with all non-essential expenses like dining out at expensive places, club/gym memberships, etc.

“Other kind of non-critical investments that are done every month can be curtailed temporarily. The key theme is for the individual to have enough liquid cash in hand in order to ride the current threat of economic downturn,” advised Valecha.