Q: My father told me I should build up an emergency fund. How much do I need?

A: Your father is wise. Unsurprisingly, the purpose of an emergency fund is to help you deal with unexpected things that come up in life. Let’s face it; no one knows what is going to happen tomorrow. And if something unfortunate should happen, it is probably going to require money.

Your emergency fund should represent three to six months of salary. If you are the sole earner in a family then you may consider socking away even more.

Your emergency fund needs to be liquid. This means that you can access it quickly if you need to. If a family member gets sick and you need to fly home immediately there isn’t time to find a buyer for your vintage stamp collection – you need to have the cash accessible. Many expats like to park their emergency cash in offshore bank accounts or in offshore term deposits. Both pay higher interest rates than their equivalent in Japan or back home, and the cash is immediately available if required.

When building an emergency fund it is tempting to rely on access to personal lines of credit to replace the requirement of keeping a few months of cash on hand. Some people feel that because they can get cash or purchasing power from their credit card, they can forego building up an emergency fund. When you further consider the opportunity cost of leaving cash in a bank account instead of investing it for higher returns, it is easy to understand why this way of thinking is popular.

Unfortunately, by relying on personal credit in lieu of an emergency fund you can get caught in a credit trap that is very difficult to get out of. Credit card purchases and cash loans are accompanied by huge interest charges, which could take years to pay off in full if you are using a card with revolving credit option.

Furthermore, in Japan many of the credit cards given out by banks and other institutions do not provide a revolving credit facility, which means that you may need to pay your entire outstanding balance within one or two months. In which case you will need to have money on hand within a short period of time, regardless of whether you rely on your credit card, or not.

If you haven’t started your emergency fund yet, decide how large it should be. Then consider the best place to park your cash to get the highest rate of return, without sacrificing any liquidity.

Money Matter Q&A