The emergency fund is the foundation of your financial security.
Before we continue, make sure you have read my previous posts on:
This post will look into the emergency fund.
Financial security requires an emergency fund. Without it, your finances will collapse. After establishing a budget and creating a system, the next step is to build a strong emergency fund.
Why have an Emergency Fund?
On the tight rope of life, your budget cannot account for uncertainty. Be prepared for the unfortunate: a medical bill, a car breakdown, a maintenance issue with your home, or even a job loss. Like the inlaws, they show up unexpectedly.
When you do slip, with your cash stretched to the limit with bills, you are forced to resort to credit cards and high-interest loans. The emergency fund is the safety net that catches you before you hit debt and despair.
Emergency Fund Benefits
Financially, you will be able to afford the most unpredictable expenses that come your way but the benefits don’t stop there.
Having a healthy emergency fund provides psychological benefits. You can spend time enjoying your life confidently with family, friends, and what interests you, as opposed to worrying about the next emergency throwing your finances off.
If there anything does wrong in your family, you can afford to be there. If something goes wrong in the household, you can cover it. If your car is written off, then you will have no problem swallowing that painful insurance excess. This is because you have dedicated money for the role of bailing you out of the unexpected.
What NOT to do with your Emergency Fund
An emergency fund is as its name intends: emergency only.
When there is a sale on, restrain yourself and don’t go rummaging through your emergency fund.
See an opportunity in the share market? Great, now hands off that emergency fund.
An emergency fund is not for a house deposit either. I would recommend saving a deposit on top of the emergency fund. Walking into your first home, might also be walking into an unexpected problem, so be prepared.
How much should you have in your Emergency Fund?
At least 3 to 6 months worth of your essential expenses should be in your emergency fund. The budget comes handy in this case because you can now calculate what you need.
Looking at the spreadsheet example, we already have your essential spending total for the week. We then multiply this by 12 to get our 3-month, or multiple by 24 to get our 6-month emergency fund.
We only use essential spending because if we do go into any hardship, our non-essential spending can be reduced to zero and we can even make some reductions in our essential spending as well.
The size of your emergency fund, whether to have 3 months, 6 months, or more depends on your comfort level and your situation.
- If you have a variable income, then you will probably need a larger emergency fund
- Finding new work is easy for you? Then you can afford to have a smaller emergency fund because you won’t be long without money surging into your account
- Congratulations! You have a new one on the way. This means your necessary spending goes up, and your emergency fund has to go up as well
- Going, going, gone! For a house purchase, you will want to muster as much as you can for the home deposit, but keep a minimum of 3 months separate just in case!
Once again, personal finance is personal. Same with the size of your emergency fund. **
Where to put this Emergency Fund?
Keep your emergency fund in a place that is easy to access in case of a proper emergency but in a place that is far from temptation. My suggestion would be to put your emergency fund in an savings account of a different bank. Out of sight, out of mind.
The emergency fund’s purpose is not there to make you more money – that’s another step altogether. Its primary role is to act as the foundation of your finances. Avoid putting your emergency fund in a managed fund, even if it is low-risk.
Keep it liquid. This means it is easy to access like cash in an online savings account. By putting all this into a separate bank that you would not access normally, you remove the temptation to spend this safety money.
You might be thinking that having money in multiple banks might negatively impact your pre-approval for a house. Count it as money you never had; your emergency fund should be separate from your home deposit.
However, you might insist on using your emergency fund to increase your chances. From my experience, if you are going through a mortgage advisor, they usually ask for all your bank accounts. In which case, you can supply your emergency fund account. Going through the bank, they will also ask if you have money anywhere else.
Getting started with your Emergency Fund
By now, I hope you are convinced that you should get an emergency fund. Starting one is easy. All you need to do is two things:
- The budget you made earlier comes in handy, again. The leftover money you have can be siphoned into your emergency fund by automatic payment everytime your paycheck comes in
- Selling items you no longer use. Take the opportunity to declutter your life. If it has a layer of dust, then you’re either unclean… or it needs a new home
If you are thinking about delaying the process of starting your emergency fund, then Osho has something to say to you: “Tomorrow never comes, it is always today”. In other words, start your emergency fund now!
After determining your budget and creating a system, the next stage is to create a strong foundation for your finances and that is the emergency fund.
The emergency fund offers financial security as well as psychological security so you can be prepared for any unexpected problem that comes your way – be it medical, car, or insurance claim.
How much to have in your emergency fund is largely personal, but aim for about 3 to 6 months worth of essential spending.
Your emergency fund should be kept in a place that is easy to access in case of an emergency and difficult to spend in a case of temptation. A separate savings account in a different bank works well this dilemma.
Finally, you never know when an emergency will strike. If it hasn’t so far, count your lucky stars because there is a reason Murphy’s law is a law. So, kick-off your emergency fund today.