An emergency fund is money set aside for unforeseen financial emergencies. It’s the ‘rainy day’ fund, preventing you from going into debt. So where should you keep it and how much should it be? Read on..
Introduction to Emergency Funds
An Emergency Fund is something everyone should have! It’s obviously up to individuals where they keep their Emergency fund and how they access it but really, it’s a good idea if it’s strictly a savings account (separate from other savings/chequing accounts), only to be used in the case of an emergency. An emergency could be anything from major home repairs or unexpected medical bills to job loss. While experts vary in opinions as to the exact amount to have in an Emergency Fund, a general rule of thumb is to ensure you have at least three to six months’ worth of expenses/bills saved. There are different options of where to keep an Emergency Fund, so let’s unpack this a bit more.
What is an Emergency Fund?
An emergency fund is money you save to cover any urgent/unexpected costs or expenses. Examples of such expenses could include car repairs or maintenance, loss of employment, or unexpected medical expenses. An Emergency Fund is an account that isn’t used for everyday expenses (which may be your ‘sinking fund’) or planned holiday trips; it is intended for unexpected expenses only. An Emergency Fund should be thought of as a financial safety net to be used for unforeseen circumstances or emergencies.
Why would I need an Emergency Fund?
It’s only a matter of time. Whether it’s medical, home-related, or even a desperately needed, overdue full body massage! (Not really, but hey, it’s your money!!), an emergency fund will prevent you from going into debt to manage financial emergencies. Using credit cards, taking out high interest loans or borrowing money from others is really not ideal and will most likely leave you making unnecessary interest payments that you will want to avoid. Everyone will have an unexpected expense at some point in their lives, so why not be prepared for it in the best way possible, avoiding debt and benefiting from the savings by storing it strategically, which brings me to my next point!
Where should I keep my Emergency Fund?
The best place for you to keep an Emergency Fund is in the bank. It’s a good idea to set up a high-interest savings account (that is separate from any other accounts). Some people invest their Emergency Fund, but this is always risky because your money (and the growth) is dependent upon your selected investments, which is never guaranteed. Some people may wish to keep an on-hand, cash Emergency Fund; this isn’t the best choice for a few reasons. It’s not good practice to keep large amounts of cash on you or in your home for obvious safety reasons, however, you’d also miss out on interest from the bank, and your money would essentially be losing value, due to inflation. Another possibility is to keep your Emergency Fund in a mortgage offset account; this option reduces the interest payable on your mortgage. Personally, this is what I do. I currently have my entire Emergency fund in my mortgage offset and I have seen a huge difference in interest charged!
How much should I have in my Emergency Savings?
Experts vary in the exact amount to save or have in Emergency Funds, but a general rule of thumb is to aim to have three to six months’ worth of expenses saved. Unforeseen events or circumstances can either be a one-off event, such as an expensive car repair, or a situation that will last for an indeterminate amount of time, such as a medical condition meaning loss of employment. It’s important to start an Emergency Fund to ensure you have access to money for these kinds of circumstances or even for bills and living expenses (groceries, prescriptions, etc.) if you lose a stable income; even if you save $100 per month, you’ll have $1200 saved by the end of the year.
Personally, I started with $100, built it to $500 when I could manage it, and I now have $15,000 as emergency money just in case I need it. This equates to about 4 months of living expenses for me, give or take a little.
“It may take you months or even a few years to build up an adequate emergency savings fund. That’s okay!”
Suze Orman
Can’t I just use my credit cards if I have an emergency financial situation?
Technically, you could use your credit cards in an emergency, however, it is not a smart choice, for a few reasons. Many, if not all credit cards are high-interest cards, meaning unless you pay off the balance in full each month, you’ll be paying a hefty fee towards interest. Emergencies or unforeseen circumstances that may arise are unpredictable; you may not know how much money you’ll need to pay unexpected bills, so if you regularly use credit cards for emergencies, you run the risk of becoming reliant on credit cards any time an emergency or unforeseen circumstance arises, which could put you into debt.
Is an Emergency Fund part of the Barefoot Buckets System?
The Barefoot Investor (aka Scott Pape), author of ‘The Barefoot Investor’ describes his Barefoot Buckets system of managing money and building wealth which involves dividing your total income (100% of your take-home pay) into three ‘buckets’:
1. A Blow Bucket: for daily expenses, the occasional splurge, and extra cash to ‘fight financial fires’ (think ‘sinking fund’, daily spending money and money to pay off high interest debt).
2. A Mojo Bucket: to provide some ‘safety’ money (essentially your emergency fund)
3. A Grow Bucket: to build long-term wealth and security (investments)
As per Scott Pape’s Barefoot Buckets System, an Emergency Fund is part of the three-bucket system (a Mojo bucket). The money in the Mojo bucket is meant to be used and considered as a ‘safety net’, and not money that is used for daily expenses (like the money in the Blow bucket).
Building an emergency fund; How do I start?
The best way to start an Emergency Fund is to set one up with a bank; opt for a high-interest (savings) account that will reward you with higher interest rates for saving. AMP suggests five steps to creating an Emergency Fund. The first step to setting up an Emergency Fund is to assess your total income; evaluate how much money you currently have, plus what you have coming in. If you have a regular income, it’ll be easier to determine your monthly income and savings budget, but if your income is sporadic, it won’t be as straightforward. The next step is to determine your monthly spending; work out how much is spent on bills, memberships, and essential costs, like groceries and transportation. How much is spent on non-essential expenses, such as entertainment, takeout, and clothing? Keeping track of your monthly expenses can help you determine how much you can budget to save for an Emergency Fund. The third step is to set up a savings goal for your Emergency Fund; the ‘ideal’ amount to have in your Emergency Fund varies according to experts. A good amount to aim for is anywhere between three to six months worth of expenses. When setting a goal, be sure that it’s realistic and attainable for your current situation. The fourth step is planning how you’ll achieve your savings goal. Once you’ve evaluated your monthly income and expenses, you’ll have a better idea of where and how much you can save (for example, you can cut down on entertainment expenses and use the savings towards an Emergency Fund). The fifth and final step is to start saving! Choose a high-interest savings account or choose your mortgage offset, set up automatic transfers into the account if you can, and opt out of a linked debit card to avoid spending temptation.
When I decided I needed to build my emergency fund beyond $100, I did everything I possibly could to build it! I started selling my household items and selling other people’s items too, for a commission. You can read my best tips on how I did it successfully and made thousands, here. I also cut down on unnecessary spending such as take away food and clothes. I made sure I was batch cooking, bought second-hand clothes for my son Andy and I reassessed all my bills, comparing providers and switching companies for better deals. Of course, a tax refund can also help to boost your emergency account! This allowed me to quickly build it up to $15k which now makes me feel so much more secure! (You can read my money journey here).
Summary of Emergency Funds
Everyone will have unexpected financial situations during their life, but how do you want to feel when these situations present themselves? Stressed and panicked? Or mildly inconvenienced? The short answer for most will be, they don’t want financial stress! I was completely broke, with debt when I first became a single mum and I’ll never forget how stressful that felt. I also have money memories from childhood, where my family was under financial stress and I still recall the impact that had on the whole family.
If you build an emergency fund and ensure it is stored in a bank account with not too easy access, you will have much more peace of mind that you can financially handle whatever life throws at you, without getting yourself into debt.
So remember, these are your financial decisions to make and your money is your money, but I don’t think anyone ever regrets having financial security, nor do they ever want to be in financial hardship. Emergency funds can literally be the difference between the two extremes. It can also help to prevent financial abuse if you have access to emergency money.
Do you already have an emergency fund? How much have you saved and where do you keep it? Let me know in the comments below!
Disclaimer:
***I am not a financial advisor so I cannot and am not intending to provide personal financial advice, I am simply sharing the benefits of having emergency funds as well as sharing my experience and how I built my own.
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