If you've ever lost your job unexpectedly, run into some stiff medical bills or shelled out big time for an unforeseen car repair, you have learnt the hard way how useful a rainy-day fund can be. In all likelihood (knock on wood) you will never need to use yours for anything truly catastrophic. But it is nevertheless important to have such a fund around, especially if you cannot rely on your family to bail you out. Even if you can, a cash stash prevents the possibly embarrassing task of asking your rich uncle to intervene.
And if you think nothing unexpected will happen to you, you are probably wrong. A survey last year from Abbey bank in the UK found that almost 80 per cent of Britons were dealt a financial blow they did not expect during the preceding year. The average bill: £1,375 (Dh9,867). Another survey from January found that one in three Britons had undergone a major life change - on the level of a job loss - in the preceding two years.
Those are sobering statistics, but they make lots of sense. Try to remember the last time you paid a large and unexpected bill. It was not too long ago, was it? The trouble is that we tend to dismiss these kinds of bills as one-offs and fail to budget for them in the future. We also tend to go to the worst places to pay for them, raiding savings accounts and charging up credit cards. In the Abbey survey, more than half of the respondents said they dipped into savings to pay unexpected charges. More than a third used a credit card. The most common unexpected expenses are bills (leaving the air conditioner on all day and running up your electric charges, for example), home repairs, car repairs and fines (for a parking violation, say). Yet most people do not have an emergency fund in place to draw on when these common-but-unexpected expenses come due.
According to an analysis of the US Federal Reserve's Survey of Consumer Finances, about 79 per cent of people have less than they should in their reserve funds. At the same time, a survey from 2006 showed that most people think they have more than enough to tide them through a traumatic job loss. So how much do you need to save? The conventional wisdom says that three months' salary is about right, the idea being that if you lose your job you will probably be able to find a new one in a few months' time, and if you suffer a major illness you should be able to pay for the first phases of treatment as you work out a way to finance the rest (you have insurance, don't you?)
If you make Dh15,000 a month, that means you would want to have Dh45,000 saved up. If that sounds like a lot of money to leave sitting around in a savings account, it is. Saving three months' salary is no easy task, either. The best way to build up such a rainy-day fund - in the UAE, more like a "sandy day" fund - is to use small regular monthly transfers into a special account over a period of a few years.
In our example above, you would reach Dh45,000 in five years by saving Dh750 per month. As a rule of thumb, five per cent of your salary saved over five years yields savings equal to three months' salary. As you build up an emergency fund, it is OK to rely on credit to cover emergencies - for many of us, it is the only option. You can also depend on savings and investments to tide you over. But you will probably build up your kitty faster than you think. It all depends on what kind of account you save the money in.
The best place to park the cash is a money-market fund. Yields are not high, but you will earn more interest than you would in a regular savings account - expect about three to four per cent- and it is easy to withdraw money when you need it in an emergency. Your broker, financial adviser or bank should be able to help you set up such an account and arrange for regular deposits into it. You may run into trouble, however, if you are an expatriate from the US, because banks here will not generally sell you investment products, fearing the scrutiny of the American tax collector.
If you are from the US, you thus face a tricky choice. You could wire cash to a money-market fund in the US, but it will probably take longer to withdraw when you are in financial straits, defeating the purpose of a quickly-tapped emergency stash. In this case, it makes more sense to put the money in a savings account, even though interest rates banks in the UAE offer are lamentably low. HSBC's "eSaver" account, its highest-yielding offering in the UAE, for example, will give you just two per cent a year on your deposit.
Whatever you decide to do, try to put as strong a lock on the emergency cash as you can. If you set it up through a broker or financial adviser, ask them to require you to call them before withdrawing any money. This will make you less likely to dip into the cash when you do not have a real emergency on your hands - splurging on a new computer is easy if you have a debit card linked to your account, but you probably will not do it if you have to ring up your broker first.
So get started building up an emergency fund if you do not have one yet. Because you never know when a sandstorm's going to hit your finances. @Email:afitch@thenational.ae