The Tribune

By Ramon Simms

ACCUMULATING sufficient savings is the best way to create long-term financial security. The question, though, is: How do you amass enough savings? Truth be told, you can never achieve this, but the first step towards creating the feeling you have saved enough is the establishment of an emergency fund.

Let us first define 'emergency'. An emergency has to be both time sensitive (it cannot wait), and of significant consequence (absolutely necessary to address). A good emergency fund creates a buffer between a constant stream of daily expenses and the reality that significant things can happen in life that might disrupt your income stream.

Just about everyone at some point in their lives becomes unemployed - whether they are new graduates looking for work; hard-working employees laid off during a recession; or explorers looking to switch jobs or careers. Life can also throw infrequent but unexpected events at you that temporarily disrupt the balance between your savings and income. You might need to cover some health-related illness; your car breaks down and needs major repairs; or you might have a large charge for something your insurance does not cover. Basically, life happens. A sizeable emergency fund goes a long way here.

A practical way to figure out a good target for your emergency fund is to review your expenses over the last several months. If your circumstances are changing or fluid, then estimate what your expenses are likely to be instead. Either way, sit down and put a number to what you spend per month on rent, utilities and groceries. A savings pool based on these sorts of essential expenses is pretty much a basic emergency fund.

Then take a look at your credit card statements, cash withdrawals, receipts and bills. Three months is a short but good timeframe. That will smooth out any month-to-month fluctuations that tend to occur in expenses that vary. Remove anything that was a one-time event, such as set-up fees if you got a new box on your cable subscription, for example. Take an average of what you spend for each of these responsibilities and total that. This is the target amount you need to save in order to live for a month without income. If you need to, and can afford to, you can turn this basic emergency fund into a 'premium' emergency fund by adding a layer of savings on top for non-essential expenses such as entertainment or travel.

A one-month basic emergency fund is great, but having an emergency fund that covers at least three months is ideal. For anyone over the age of 18, I do not think I need to make a case for how fast four weeks can zoom by. If you can afford to save more, save it - and save for longer. If you anticipate needing more emergency funds for anything, save more and save for longer. Three months is a good target, though. It is not forever but will likely give you the time and space you need to make important life decisions without feeling rushed or pressured.

Now that you know how much and for how long, it is time to talk about where. It is an incredibly good idea to separate your emergency savings from your regular checking and/or savings accounts. This helps limit the temptation to use those funds prematurely on other things by leveraging the old adage: 'Out of sight, out of mind.' Get in the habit of adding to your savings fund regularly and forgetting about it. If your bank has the feature, setting up an automatic transfer to your emergency savings account that is timed to coincide with your pay cheque. This helps you establish this routine easily.

Once you start accumulating enough savings, put your money to work. Commit your savings to a certificate of deposit and earn interest while you build your emergency fund in the process. Another alternative is to put your savings in a money market fund. These tend to earn slightly higher interest rates than traditional savings accounts, but are more liquid in comparison to certificates of deposits that often restrict access to your money for months at a time.

There is one last thing with respect to emergency funds. We already covered some significant life events that would qualify for emergency usage, but before you use anything from of your emergency savings fund, ask yourself: Is this something that is urgent and important?

If the answer is 'yes' and 'yes', then by all means go ahead and use the fund for exactly what it was intended for. Then, as soon as you are able to, start replenishing it to restore its status for future use.

Everyone needs to save. Unexpected financial problems do not discriminate by race or economic status. Never being caught unawares because you have an emergency fund at hand is a powerful buffer that can save you from difficult financial decisions and dangerous personal debt. Make sure you are prepared.

NB: Ramon Simms is a management professional with more than 10 years' experience in finance, operations and technology. He holds a BA in Financial Economics and an MBA in Entrepreneurship. He is a managing director at IFF Lts (www.iffpros.com) Bahamas, and you can reach him at ramon@iffpros.com.