Emergency fund, as the name suggests, is the money you set aside that you’ll use in times of emergency.
As MoneySmart.Gov.AU defines emergency fund:
An emergency fund is a money you set aside to cover urgent or unexpected costs. This could be car repairs, unexpected travel, or an urgent medical bill. It provides a financial safety net so you don’t have to borrow money if something happens to you or your family.
You’re probably a very positive person and everything is doing great in your life right now: a nice house, nice car, great husband, respectful kids, lovely family and stable job in the city. But no matter how good things are, they can always go bad. To quote Murphy’s Law:
Everyone has emergencies, whether we like it or not. We all will face emergencies or unplanned negative events, not only once but multiple times in our lives. It could be a medical emergency, job redundancy, car blows up, transmission goes out, family trouble or even burying a loved one. It could also be small things like your toddler accidentally throws your phone and it’s not working anymore so you need a new one, or having to book a flight on short notice to see a sick loved one.
These could happen to anyone and have proven to make people more broken every single time, but with an emergency savings fund, you will get by and will pass all these negative events.
What is an emergency fund?
An emergency fund is money you’ve set aside – either in one lump sum or slowly over time – to help you in a situation where you need immediate access to money you might not have had otherwise. It is important that the set-aside amount is liquid, that you can access immediately, but not too easy to access that you will spend the money whenever you feel like it.
Say you needed a root canal therapy which will cost you between $2,000 to $3,500 if you don’t have health insurance to cover for it. If you have an emergency saving fund, you can easily decide to go through the treatment and skip getting anxious about where you going to get the money, or if you managed to get the money through your credit card, on how you’re going to pay for it.
Yet there are too many people in Australia who have no savings at all, let alone an emergency fund, and the stats are working against us.
According to AMP Bank, one in five Australians have less than $250 in savings. According to BT Financial Group’s consumer index, 21% of people have no savings to fall back on. A similar study by Citi found that 36% of people had less than $1,000 in savings for emergencies.
What are emergency events to spend your emergency fund on?
There is a little grey area on where to spend the emergency fund on. I’m guilty of this one – as I think of this fund as part of my ready cash that I can spend anytime I want on anything I want.
Emergency fund is NOT for buying new pair of shoes on sale or for a short holiday in Noosa; IT IS FOR EMERGENCIES ONLY.
Most of us, myself included, uses credit cards to catch all of life’s emergencies. Some of these so-called emergencies are events like end-of-financial Year, Christmas or Boxing Day. Christmas is not an emergency. It is always happening in December – they haven’t moved that event ever.
If your kids need winter clothes because the season has changed, well it always does and there’s no surprise on that. This is NOT an emergency; it should be part of your monthly or weekly budget. If you don’t have a budget for it, it will definitely feel like an emergency.
So what are the genuine emergency events?
According to Vanguard, here are some of the top emergencies people face:
- Job loss
- Medical or dental emergency
- Unexpected home repairs
- Car troubles
- Unplanned travel expenses
How much emergency fund should you have?
Rule of thumb – the emergency fund will cover three to six months of your expenses. That’s pretty significant, especially if you think about your monthly income and 100% of it goes out as expenses. I hope this isn’t the case.
Don’t associate emergency fun with a specific amount, but think of it as covering an amount of time. This means that the amount will vary, depending on how long you can afford not to have a job for example.
The three to six months is based on an estimate by job agencies that roughly how long it takes people to find a new job. If your job is in demand, you probably less than three months’ worth of expenses as emergency fund.
So let’s say you have decided that you will work on at least three months’ worth of your expenses. These expenses should include all the fixed costs in your household like:
- Rent or mortgage repayments (that’s the biggest one)
- Children’s Expenses (tuition fee or child care fee)
- Transportation (including petrol and toll fees)
If you don’t know how much you’re spending on the aforementioned, you better start looking at your bank statement for historical transactions or start doing your budgeting now.
You can use a budget planner app to estimate how much you spend on basic goods and services. There are heaps of apps (free and paid) that can help track your spending and even categorise them.
Commbank app is actually pretty good in categorising your spending, if you’re paying attention.
I personally use a good ole spreadsheet to track our spending. And because I’m an Excel geek, I even set them up with formulas and colourful graphs to make it more appealing. I will definitely share that in my future post.
How to start an emergency fund
Once you’ve done step one, which is working out your six months’ worth of expenses, you can now move onto the next steps and start saving your emergency fund. So how are you going to do this?
1. Save $1,000 Quick as a Starter Emergency Fund
You need to have a head start and be on top of your finances. Saving $1,000 fast will cover you with little emergencies that come your way. And when I say quick, you don’t have to wait for your next salary or the next month after that to set aside the starter emergency fund.
You can get this by working extra hours, selling some stuff in Gumtree or Facebook Marketplace or do some work in Airtasker. If it looks as though it is going to take longer, do something radical – drive an Uber or UberEats, work part-time, or sell something else.
2. Set up a separate savings account
It is important that you will set a separate account for your emergency fund. It should be accessible though – not like something you need to pay a brake-fee because you put them on term deposit. Otherwise, how can you easily access it in case of emergency.
Putting it on a separate bank account will prevent you to get tempted to spend the money to non-emergency events – like Boxing day or Christmas sale events.
If you have the time, find a high-interest savings account to put your money. Do you know that the big banks in Australia only give an average of 1.6% interest? And that is not even for a year, but only for the next three to six months of your deposits and will earn 0.1% on succeeding months? So let say you’re a good saver and have $100,000 in the bank, that will only earn $475 for first year, and $100 on succeeding years.
3. Automate your savings
Once you’ve set up your separate bank account, you can now deposit the lump sum of $1,000 and set up automatic transfers from your payroll account. How much you choose to transfer is up to you.
Personally, we set aside 10% of every paycheck and automatically transfer that until we hit the three months’ worth of expenses. In the event we have spent the money due to an emergency, we’ll replenish it immediately when the money is available.
Then, we pretty much set and forget about it and enjoy our peace of mind.
4. Maximise your offset account
If you have a home loan with an offset account, you can use the offset account as your emergency fund. This will lower your home loan interest payments, and means you can access your money quickly.
5. Keep adding to your emergency fund
If you get some extra money during the year, like a tax refund, you can use this to boost your emergency savings.
Benefits of Having Emergency Fund
Aside from financial stability, there are other benefits to having an emergency reserve of cash.
Aussie Money Blog’s two cents
An emergency fund is a must. Every household or every person should set aside in case Mr. Murphy pays a visit. No matter how good the weather is – it is going to rain, so you need a rainy-day fund.
An emergency fund is for emergencies. It’s not to be used because you feel like buying some new clothes that weekend, or even if you just want to top up your main bank account. There’s no real point to having one if you’re just going to withdraw from it all the time.