The Importance of Building an Emergency Fund
Your car breaks down, you need to book a last-minute flight to see a sick family member, you get a medical bill that’s not covered by insurance, your pet gets sick, your fridge breaks down or a family member is in a tight financial spot. These are all situations where you’ll need immediate cash on hand (not locked away in a term deposit or invested).
You need the money right there and then, and don’t want to think about the cost. I started to think about building an emergency fund when I read this poignant article a few years back. It really forced me to consider what an emergency fund stands for; flexibility, security and a safety net. It also means I won’t need to resort to using a credit card or personal loan when an unexpected financial event occurs.
So What Exactly is an Emergency Fund?
Your emergency fund is your financial runway for whenever you run into unexpected trouble, and need to cover some financial costs. It also gives you breathing space between your bills, so you’re not living paycheck to paycheck. Typically experts suggest putting away 3–6 months of living expenses to alleviate financial stress and give you a buffer in case of unexpected illness or job loss. However, if you’ve got competing priorities or are currently paying off debt, it may be better to start with putting aside one month of living expenses, and building up your emergency fund over time.
The amount that you put aside is completely up to you, however, reasons that might lead you to need a larger security net include having dependents, contract/casual work or a close relative living interstate or overseas. It’s going to take time and that’s completely okay, you just need to get started!
Building Your Emergency Fund
Open a Separate Account
First things first, open a completely separate bank account that isn’t linked directly to a spending account. Make sure the account isn’t charging you any fees and preferably it is paying interest (compare savings accounts here). This account will be used solely for your emergency fund, and you won’t let yourself access it for non ‘emergency’ situations.
Set a Goal + Budget For It
Your next step is to work out how much you will need in your emergency fund. Whether $500 or 3-months of living expenses, you need to work out the appropriate number for you. Once you’ve got a number you’ll need to make room in your monthly budget for it. If your goal is $1200, then you might decide to put $100 aside in your budget each month for this. If you’ll need $6,000, then maybe putting $250 a month for two years aside is the way to go.
Set Up Automatic Payments
Once you’ve worked out how much you want to move into your emergency fund each month, set up an automatic payment from the account you receive your paycheck into, into your emergency fund on a monthly basis. If that’s not an option, put a recurring calendar event in your diary, which reminds you to move funds into your emergency fund on a monthly basis.
By setting up a bulletproof personal finance system, you can start to dominate your finances by having your system passively do the right thing for you, leaving you to focus on the things that really matter.
Source: Ramit Sethi
Be Consistent
The key thing to keep in mind is that you need to be consistent with building your emergency fund. It may take a few years to set it up, and you may need to use it along the way, but getting started is the most important part. If you have any unexpected windfalls such as a tax refund or bonus or are able to make some extra cash on the side, it might be a good opportunity to boost your emergency fund.
The most important part is not being afraid to use the funds you’ve put inside if something unexpected does happen. Just think of it as your personal parachute, that you can open in case of emergency (and if you do, start repairing it straight away)!
Kate — HTM Founder & Editor
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Important Information
The information on this blog and website is of a general and educational nature only. It does not take into account your individual financial situation, objectives or needs. You should consider your own financial position and requirements before making a decision, as we are not an advisory service. We recommend you consult a licensed financial adviser in order to assist you. The information is based on assumptions or market conditions which can change without notice, and this will impact the accuracy of the information provided. This website and blog occasionally provide links to third-party sites, aimed at helping you gather the information required to make an informed decision — we may receive payment for these referrals.
