The critical role of emergency savings

Anne Cabot-Alletzhauser*
2017-07-08 10:00
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 Anne Cabot-Alletzhauser. (Supplied).

Cape Town - Do you have something set aside for sudden emergencies? Anne Cabot-Alletzhauser, head of the Alexander Forbes Research Institute, points to some sobering facts.

According to Old Mutual data, if suddenly asked to cover a R10 000 financial shock, 57% of employees earning between R6 000 and R13 999 per month would need to borrow the funds. And 30% of the same group would be unable to meet the demand by any means.

Of those employees with salaries between R20 000 and R39 999 per month, 46% would need to borrow the funds and 11% would be unable to meet the demands by any means.

What these numbers suggest is that a disturbing number of South African employees are “just one destabilising shock from hardship".The lower the income, the more pronounced the shock is likely to be. 

The harsh reality is that financial shocks are without prejudice – they can strike any one of us at any time. 

But the rise of a credit mindset has also created a sea-change in the way individuals make their financial decisions. Gone are the days of constraints that could limit the number of financial commitments an individual could make.  

Research argues that the more sophisticated a country’s credit and financial markets, the more difficult it is for its population to maintain a level of financial literacy. South Africa’s formal financial markets are renowned for their first-world sophistication.

But our financial woes are complicated further by the fact that there’s another whole world of borrowing and savings, the informal sector, which rarely gets included in the total picture for the individual.

Emergency savings do more than just prevent a financial maelstrom. They also can provide individuals with the first tentative step towards asset accumulation and management. Emergency savings “enable people to achieve other goals and avoid other hardships”.

It’s as much about being able to meet unexpected expenses as it is about being able to take advantage of unexpected opportunities (such as an unexpected training or educational opportunity).

But perhaps the most powerful attribute of emergency savings is the psychological impact they have on the saver. We know, for example, that people’s perceptions of their financial well-being are typically more influenced by their assessments of their current cash balances than by any valuation of their long-term asset accumulation potential. We tend to focus on how well we could deal with a sudden financial crisis, rather than absolute levels of wealth.

An emergency savings habit addresses two important issues. Firstly, should a financial crisis occur, it allows the individual to deal with it without destabilising any long-term savings strategies.

And secondly, it has an impact on time-frame tolerance: the greater the financial cushion, the more willing investors are to adopt longer-term time horizons for other savings goals.

Research also tells us that there’s a strong relationship between establishing an emergency savings habit and economic mobility, intergenerational wealth transfer and family stability.

Perhaps we’re missing an important opportunity by not understanding the critical role emergency savings play alongside long-term savings.

* Anne Cabot-Alletzhauser is head of the Alexander Forbes Research Institute.

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