Pat Magadla | Senior Manager | Business Development | Old Mutual Investment Group | mail me |
Dividing your savings into two separate categories – each with its own unique purpose – can provide clarity and boost your progress towards achieving your financial goals.
When it comes to saving money, having a clear strategy in place can make all the difference.
Budgeting
The most effective tool for prudent financial management is budgeting. A budget helps us to plan for our mortgage or rent, our car instalments, school fees, food, petrol, insurance, and so on.
There are some things that one cannot anticipate, loosely termed your ‘emergency needs’. These could be medical expenses from an illness or accident, car repairs or a large home appliance which breaks and needs replacing. Your fridge stops working, geyser bursts, or the motor for your gate breaks down. You spill coffee on your laptop. You need to replace these. So you also need to plan for this by setting aside money each month in an emergency fund.
Perhaps most important of all, your emergency fund is a critical safety net in the event that you find yourself unemployed or your business closes down. It is advisable to have enough money to cover at least three to six months’ living expenses saved in an emergency fund in the event of unemployment, to tide you over until you begin to earn an income again.
Unanticipated expenses aren’t the only ones that might not fit into your monthly budget, though, which is why I also advocate for something called a ‘sinking fund’. This is for expenses that are not paid monthly, but which you know are coming.
For example, a holiday or home renovations that you are planning. Perhaps you want to install solar panels on your roof, update your kids’ wardrobe as the seasons change or they outgrow their clothes or replace your car tyres next year.
The separation of sinking and emergency funds
The separation of sinking and emergency funds – which are separate from your current account – can offer several advantages.
The most obvious being that you are less likely to derail your monthly budget (or go into debt) in order to pay for unexpected expenses. You are also less likely to dip into sinking funds for emergency expenses, and vice versa. This will leave you in a far more stable financial position, and also improve the odds that you’ll achieve your financial goals.
How to create a sinking fund
- Firstly, decide which anticipated expense you’d like to save up for, and whether you’d like to save towards more than one goal at a time.
- Research how much each goal is likely to cost and create a target amount.
- Refer to your budget to work out how much you can afford to pay towards each goal, each month. From this, you can calculate how long it will take you to save up for each target.
- Now, decide on an appropriate savings account. You may wish to open more than one account for separate sinking fund goals. You could use something as basic as a separate savings account with your bank, where you’re putting that money aside each month. This is acceptable for a short-term savings goal. If you’re saving over the longer term, though – say, over a year or two – a money market account can offer a better interest rate and help to grow your funds, whilst removing any risk of capital loss.
- What’s important for both sinking and emergency funds, is that you are able to access your money within 24 hours, in case of an emergency – so it’s important not to choose a savings vehicle where your funds are locked in for a long period of time. Other appropriate options to help grow your savings include low risk unit trust funds such as the our Interest Plus Fund or the Income Fund. These vehicles offer a more attractive yield and liquidity without the volatility you would get from a higher equity exposure fund. If you are looking for something that is faith-based and Shar’iah compliant, there’s our Al Baraka Income Fund.
- Start saving!
How to create an emergency fund
- Decide on a target amount for your emergency savings account. A good rule of thumb is to have enough money to cover three to ideally six months’ living expenses.
- Refer to your budget to work out how much you can afford to pay towards this target amount each month. From this, you can calculate how long it will take you to reach your goal.
- Choose an appropriate savings account: the same advice applies as in step 4 of ‘How to create a sinking fund’.
- Start saving!
Set up an automatic payment schedule on your current account so that your contributions to both your sinking and emergency funds are deducted as soon as you receive your income each month.