Pause for a moment and consider how you would cope if you were suddenly faced with a crisis such as a major, but not life threatening, illness or the need for an extended period of time off work etc?

The need for an emergency cash fund you can draw on to see you over the rough patches of life are imperative. Even if you have no debt, an emergency cash fund is still essential. So how much would be enough for you? Would liquid funds of say between three to six months expenditure be sufficient if something untoward occurred?

Some would no doubt revert to a credit card to see themselves through. However, at some stage those bills would need to be paid along with 21% plus interest.

What if your particular circumstances have not improved in six months? The point being the term off work is unknown at the outset. How much you need really depends on the lifestyle you lead, the financial commitments you have and the extent to which you could tighten your belt if you had to.

Probably the best plan is to provide for the worst-case scenario. Firstly, calculate your current monthly essential outgoings. These are the expenses which have to be paid, such as insurances, mortgages, rates, food bills etc, but you could probably do without the things you merely want, such as Sky TV, mobile phones etc.

Take this figure and multiply it by the number of months stand-down your income protection insurance requires, plus say another month. This should be your target emergency figure. Sorry, did I hear you say “you don’t have such cover“? Well, you are a duffer, and, along with medical insurance, you should have this protection available to you.

Your greatest asset is your ability to earn an income and, as such, highlights the importance of having income protection insurance, unless of course you have substantial private means of covering such an incident. If you have such cover and have elected a period of “stand-down” (the period before your income protection is paid), how do you intend funding this period?

Also, take into account the insurance company may, for some reason, need to delay payment of your cover over and above your “stand-down” period. Hence, the extra month referred to when calculating your cash buffer.

Another point to consider is an indemnity income protection policy will only cover 75% of your gross income. How then are you going to fund the remaining 25%? Should you not include this amount in your cash buffer? There are insurances available which will cover the 25% shortfall, but, as with all things in life there is a cost.

If you have to draw from the emergency fund build it back up after your crisis has passed.

Source: David Solomon, Director, New Zealand Financial Planning
Telephone: (03) 375 4040 Email: davids@chchnzfp.co.nz
“A Disclosure Statement under the Securities Markets Act 1988 relating to the financial adviser associated with this article is available on request and free of charge.”

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