An emergency fund goes by many names, reserve fund, stockpile, savings, fuck you money and many others, but they’re all the same. It’s a collection of money that you keep for those unexpected moments that can derail your life as you know it. Some of the more common examples include unexpected car or home repairs, medical expenses or loss of income. None of those things are fun, and even with an emergency fund, you’ll likely be at least a little stressed. Still, this money gives the ability to weather the storm and get back to your regular life. The secondary and often over-looked benefit of an emergency fund is that it allows you to leave your investments untouched in your time of need. If the economy is falling about and you’ve lost your job the last thing you want to do is start selling investments. They’ve. Just declined 30%, it’s literally the worst time to need money. This is where your emergency fund shines.
What Is an Emergency?
It’s critically important that for your emergency fund to work you need to understand what an emergency is. Payday is a week away, and the new FIFA just dropped is not a reason to dip into the emergency fund, neither is an overdue trip to the nail salon. These are both things that can wait a week. It may seem trivial, but being able to exercise self-control and not dip into your savings for little things like that can have a substantial phycological impact. If you make an exception for something small like a video game, you’re more likely to dip in again in future. Stop the habit before it starts, if this isn’t something that wasn’t unforeseen and a severe risk to your way of life, then don’t touch the fund! This includes Christmas presents, they are not unexpected. You have all year to save for them, do it. Being laid-off unexpectedly is a perfectly good excuse to access your savings. Your best friend inviting you on a last-minute interstate trip when you have no money isn’t.
How Much Should Be in My Emergency Fund?
This is a hot topic on many online forums, and the amount will differ for everybody. For this reason, it is generally stated in terms of your monthly expenses rather than a set amount. Some people encourage 3 months of expenses, others 6 and some even 12. This can seem quite scary if you’re just starting out and you’re monthly costs are $2,000. This could make your required fundas high as $24,000, and you’re undoubtedly wondering ‘how the hell can I save that much?’. So don’t, not yet anyway. Start with something small. $1,000 is a great starting point as it’s something we can all save over 12 months, and although it may not feel like a lot, it’s a considerable amount of money in a crisis. A 2019 Budget Direct Home Insurance report found that over 55% of Australians couldn’t come up with $1,000 in an emergency. Let’s start by getting you in the top half, and we’ll go from there. Build your emergency fund to $1,000 then look to grow it to $5,000, then $10,000 if you feel that it’s necessary. Personally, I think $10,000 is a massive amount of money to have available for an emergency. If you’re an individual, there aren’t many expenses that can arise, which will cost you more than $10,000. If you’re the breadwinner for your family, it may be worth having a little extra. In this situation, it may be advisable to consider the 6 or 12-month expenses rule.
While it’s vital to ensure your emergency fund is large enough to be there in your time of need, it’s also essential to not overdo it. The trade-off with having money be easily accessibly is that it’s not likely to be earning a very high rate of return. Most savings accounts currently pay below 2% while stocks on average return around 10%. This means that every dollar in your savings account is sacrificing 8% returns in exchange for being readily available when you need it. Don’t let this discourage you from building your emergency. Just be aware that once you’re up to a substantial amount whether that be $10,000 or 6 months expenses, it’s worth considering if an extra $5,000 might be better allocated in your investment account.
How Do I Build an Emergency Fund?
Knowing how much you should have in your savings account is a lot easier than actually having it there. So how do you build from nothing to that initial $1,000? There are two options; generally, the easiest is to cut expenses. All of us over-spend from time to time, we all pay for something we shouldn’t. Maybe you have takeaway dinners once a week, perhaps you spend $50 on beer a week, or possibly you’re currently paying for 2 streaming services. Remember that you don’t need to give up all of the things you like to achieve financial freedom. If you like having friends over and drinking a few beers that’s completely fine. Maybe look to buy a 6-pack instead of a slab, you’ll pay a little more per bottle, but you’ll cut $50 down to $20 a week. It doesn’t matter how much you’re contributing to your savings, it’s essential that you are and that you’re doing it regularly. Even $30 a week will build up over time.
If you’re not in a position to cut your living expenses, the next option is to increase your earnings. Most people will say this is easier said than done but if you really look and you’re willing to do tasks that others may not you’ll find there’s always money to be made. If you jump on Airtasker, there’s almost people looking for somebody to mow their lawn or any number of other relatively easy to do jobs. You could get a second job to generate a few dollars on the weekend or work a few hours of overtime to boost your existing payday. If you’re willing to do the work, I think you’ll find there are almost always ways to increase your income.
Where Do I Keep My Emergency Fund?
You’ve now located some extra money that you can put towards your emergency account but where should this money be going? The most important aspect of an emergency account is that it needs to be readily available in an emergency, that means it needs to be liquid. Stocks are not the place for your fund, they can take up to 3 days to sell. Your house is also not an emergency fund. To ensure that the money is there when you need it you should keep your emergency account in a savings account. It can be with your everyday bank or another bank that’s willing to give you a better rate of return. In fact, I would encourage you to create an account with the bank that will provide you with the highest interest rate on your savings account. ING is my bank of choice for everyday banking as savings, they offer one of the higher interest rates, and I just love their easy to use interface. Other banks that offer competitive rates include UBank, HSBC and Bankwest. These are smaller banks meaning they are more prone to service outages but if you’re only using them for your savings account a 1-2 hour service outage isn’t going to be the end of the world. Although ING is excellent, it does go down for short periods from time to time. If you elect to use them as your everyday account, I would encourage you to have a secondary account or credit card with another bank as a backup.
Does My Credit Card Count as An Emergency Fund?
No! A credit card is not an emergency account. Unlike a lot of people in the personal finance community, I would encourage you to own a credit card. They provide liquidity in an emergency and can help build your credit score. That being said, it’s important to understand they are not a substitute for an emergency fund. If you lose your job while relying on a credit card, you can quickly build debt that accrues interest at a ridiculous rate causing even more trouble. How I would encourage you to use a credit card is to pay off something small each month to help you build your credit score and only pay for things that you could afford to buy with cash. This will allow you to delay a payment, maximise your savings interest and avoid any unnecessary debt.
At the end of the day, the size of your emergency fund, its location, and what you use it for are all entirely up to you. Consider what we’ve stated above but find the best mix that best suits you, and once you’re happy with what you have, it’s time to start investing.