It was February 21, 2020 when one of the world’s most important stock markets began to collapse.
Suddenly Dow Jones (USA) after a very good year (2019), began to decline and in fact very quickly.
A few days earlier on 12/2 the index had achieved All Time High reaching 29,597 points, and it seemed just a breath away from the 30,000 points.
But the stock markets and the global economy would soon be in for a surprise.
It was the end of 2019 when a new virus appeared in China. In the beginning the phenomenon seems to be under control and scientists as well as the markets do not seem to be particularly worried.
However, as the virus began to spread mainly in Europe and countries such as Italy began to show many cases every day things changed somewhat… for the worse ..
The Dow Jones fell to 18,187 points in about 1 month on 23/3/2020, a decrease of 38.55%, one of the fastest and largest declines in the index’s history, reaching the bear territory, of course.
As expected, the real world economy would also be hit.
Although at the time of writing this article it is still too early to measure the real wounds, there is already evidence of what this situation will look like.
In the United States, for example, jobless claims have skyrocketed for the first time in years.
Of the 200,000 claims per week on average, 3,283,000 claims were suddenly announced in the week ending March 26, with an additional 13,254,000 in the next 2 weeks and 5,245,000 on April 16, 2020.
This gives us a total of 21,782,000 jobless claims in just 4 weeks. A number that is expected to rise much more as unemployment is expected to exceed 10% in USA.
And that’s only for USA. Things are already difficult for most countries around the world.
The problem is not the crisis that has been created and what the consequences will be. The problem is how prepared people are for that.
And unfortunately they are not. A very large proportion of people do not have a fund ini place for emergencies like this.
But what do we mean by Emergency Fund?
An emergency fund is an instantly available source of assets to help people navigate financial dilemmas, such as job loss, a debilitating illness, a major home or car repair, a major crisis such as the pandemic which we live now etc ..
The purpose of the fund is to improve financial security by creating a cash security net or other liquid assets that can be used to cover emergency expenses.
By asking “experts” or searching the internet for information you will find various ways to build such a fund.
However, all articles agree on 2 things.
First, it is important to have such a fund either individually or as a family. And if you couldn’t understand why before, I think you understand now.
2nd this fund must have the maximum liquidity.
I have personally chosen to have this cash in cash immediately available.
What should be the size of the fund?
The prevailing opinion on the matter is 3 to 6 months of expenses. For example, if you have 1,000€ per month in expenses, then you have to make a fund of 3,000€ to 6,000€.
I personally do not follow this model.
My goal is to reach a minimum capital of 6 months and a maximum of 12. But not calculating all of my expenses but my monthly liabilities.
What is the difference between all expenses from liabilities?
My wife and I, for example, may have about 2,500€ a month in total expenses.
Of the 2,500€, however, about half are liabilites, as you can see here.
In case of an emergency, the priority is to be able to survive without having to sacrifice important things in your life, such as cutting off your internet connection, selling your car, renting another smaller house or worse. to lose your house because you can’t afford the monthly payments on your mortgage.
Daily coffee or weekly shopping can wait if you find yourself in a crisis so these are the ones you will want to sacrifice.
With that in mind, I started making my own emergency fund, as you can see here, at the end of 2018.
As our liabilites are currently about 1.250€ per month, my goal is to make a fund with 12x my monthly liabilites , ie 15,000€ in liquid cash.
Why 6 to 12 months of liabilites?
Statistics show that the first 2 to 5 months are the most difficult and important in a crisis situation.
So having 12 months of cash liquidity will help me deal with any difficulty even in the extreme scenario of 0€ income for an entire year.
It will also get me out of the difficult position of making decisions that I may later regret, such as selling parts of my assets that are significant, at a much lower price.
Finally something equally important. It helps me sleep better at night no matter what happens.
How do I build such a fund?
This fund, like cash in general, has a downside. It does not grow in value. To be precise, it is getting smaller, but we will analyze this at another post.
That’s why I chose to build the fund in the long run in parallel with my investments, unlike most tips that suggest first building an emergency fund before you start investing money.
So in 2018 I only had 850€ at the fund. In 2019 I reached 3,500€. My goal for 2020 is to reach the fund at 8,000€ and I hope to have reached 15,000€ by the end of 2021.
After 15,000€ what?
In this amount I stop putting extra money in that fund. The only way to increase the fund is to increase our monthly liabilities. If, for example, our liabilites rise to 1,500€, then the fund should reach 18,000€ in total.
Because we have to hope for the best but plan our lives for the worse, we should all have such a fund.
If you are currently one of those who does not have one, you should do one because it is almost certain that one day you will need it. And when you need it, you wish you had one.