In an ideal world, we shouldn’t have to rely on our savings or growing home deposit to access money in an emergency. Worse still, it's best to avoid putting ourselves into debt or further financial hardship through resorting to credit cards or high-interest personal loans.
Here’s why backing yourself with an emergency fund is a strong (and smart) financial strategy and the seven steps you can take to make it happen.
A well-planned emergency fund is one of the many golden tickets to buying yourself peace of mind and financial freedom. Who doesn’t want that weight off their mind?
It’s the money you put aside for a 'rainy day' to cover the cost of unexpected (and often chunky) expenses, like when your car breaks down, the fridge stops working, for a medical emergency, or losing your job.
A well-padded emergency fund is your financial safety net, giving you the means to cope if (and when) those bumps come up. It means you won't have to rely on credit cards or high-interest loans, putting yourself into debt and risking financial hardship.
Like an insurance policy, while we don't like putting money towards it, we're definitely thankful that we did in times when we actually come to need it.
However, unlike paying an insurance company to insure you, your emergency fund is effectively insuring yourself, so the money is always yours and accessible whenever you need it – without having to put in an insurance claim and pay any excess either. Win-win!
Here’s the thing. Emergency funds really put the ‘personal’ in personal finance. The exact amount is up to you, your personal circumstances and how you feel about financial risk. And happily, there’s plenty of wriggle room to help you find a spot where you’re comfortable.
Financial guru Scott Pape of The Barefoot Investor fame recommends three months’ worth of living expenses as a solid measure to kick off this bucket of funds. Some experts believe you should set aside least three to six months' worth of living expenses, and others even suggest that you should plan for saving a year's worth of income.
The answer to how much you need is up to you, whatever you're most comfortable with, and that might be a specific dollar figure or several months’ worth of income.
If you work in an unstable industry where layoffs are more common, you’d be safer aiming for the higher end of the recommended range. But consider how much makes sense for your personal circumstances. Some people feel completely fine with three months on hand, while others say less than six months of living expenses in their fund makes them anxious. In any case, your individual circumstances and feelings about risk will play into your decision.
We suggest three months as a good starting point. Once you have three months saved up in your emergency fund, see how you feel. If you’re still feeling uncertain or insecure when you hit this figure, keep building up this account until you get to a point where you feel comfortable that you've set aside enough funds.
After you've built up the safety net you need, you can consider allocating the regular amounts of money you'd been putting into your emergency fund into funding other goals. This could be boosting your savings account, or investing any discretionary money (outside of your emergency fund and other savings) towards setting up your financial future.
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Once you’re settled on your target amount, let's start building up that safety net. Just as you have with other big savings goals (hello, growing home deposit), you’ll know it’s worth starting with clear steps and achievable milestones to get you there.
Hot tip: The Australian Government’s Moneysmart website has a great savings goals calculator and links to resources that can help calculate those incremental savings to you reach your target.
Here are seven steps to build that fund fast.
1. Allocate a dedicated savings account: When your emergency fund’s mixed in with your regular savings (or, worse, your day-to-day dollars), it’s easier to justify dipping into it. So set up a separate and easily accessible, high-interest savings account and label it accordingly. This will show you how much you’ve saved, and you won’t be tempted to dip in.
The alternative is to maximise an offset account attached to a home loan, if you have one. Using your offset account as your emergency fund will also lower your home loan interest payments and give you quick access to your money if you need it.
Hot tip: Whenever you set up a new bank account, understand the associated fees and read the fine print to know what you're getting into and decide if it's the best account to meet your needs.
2. Calculate the amount you need to contribute: Saving is a breeze when you’ve got a target to work towards. Using the savings goal you've decided on for your emergency fund, work out that dollar figure you'll need to put in each week, fortnight or month and start saving towards your magic number!
3. Automate those savings: Take the hassle out of the process and set up automated transfers between the account where your paycheck lands and your emergency fund. Or check with your payroll team to see if they can direct a set amount of your wage into your emergency fund account. Automating money transfers and payments is a great ‘set and forget’ move, and you can sleep easy, knowing your safety net is growing.
4. Manage your budget: Ensuring you have enough money to stick to your recurring emergency fund contributions will mean having a good budget to keep track of the cash you’re splashing and not overspending. It also means identifying trouble areas in your spending and any lifestyle measures you may need to meet your savings commitment.
5. Boost your fund whenever you can: If you want to reach your target balance sooner, look to boost your savings whenever you get the chance. If you come into some extra money during the year (e.g. a little freelance gig, cash gift or tax refund), you can add this to your emergency savings. Check out other ways you can supercharge your savings without even noticing.
6. Access your account only for emergencies: It's important to remember an emergency fund is to be used for exactly that: emergencies. It's not for the pair of shoes you've been eyeing off that's just gone on sale, or for taking an extra holiday. Save your emergency funds for unexpected expenses that you need to pay quickly when other funds aren't available.
Hot tip: If payments can be delayed or split over smaller repayments, you may not need to withdraw from your emergency account.
7. Top up your emergency fund to maintain your buffer: Whenever you need to access the money in your fund, make sure you replenish it afterwards to get it back up to your target balance. Over time, if you keep needing to dip into it, the balance could get so low that it no longer offers you much of a safety net. That's why it's important to keep an eye on the balance to ensure you have the buffer you need at all times.
Life can be unpredictable. Extra expenses could come your way at any time, but having an emergency fund in place should help you weather any storm.
While it may take time to build up your emergency fund, it doesn't have to be a hard slog. Obviously, the more you can save, the better. But even if you can only save a little at a time, or can only contribute sporadically, just get started and you'll see it grow.
Your efforts in creating your personal financial safety net will be rewarded in giving you greater peace of mind and helping to take off that little bit of stress whenever these road bumps occur.
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