An emergency fund is a small lump sum of money that is available at a moment’s notice in the event of an emergency. It provides short term security in the event of unexpected large expenses. The most common uses we see include dentist bills, veterinary bills, smart phone repairs, car insurance excesses, broken fridges or even a large phone bill.
Although it’s one of the simplest concepts in a financial plan it is seldom handled well.
According to a recent survey1
Less than 41% have at least $5,000.
30% of Australians have less than $1000 available
Almost one in eight (12%) have less than $100
So how much do you need in your emergency fund? The well recognised minimum is 1 month’s expenses – so if, as a couple you spend $8,000 a month – you should have at least that much in your emergency fund.
Ideally, building that up to 3 months’ reserve will give you a much greater sense of security – and can even allow you to reduce your insurance costs through increasing the waiting period on your income protection!
This also removes the need to have a credit card, and any temptation that brings!
How can you build up your emergency fund?
The first step is to build a realistic budget. This will give you a guide as to how much 1 ad 3 months’ expenses actually is, as well as giving you an indication of your savings capacity.
Make sure when putting your budget together you don’t just list your “fixed expenses” or Bills, but try to accurately account for your variable expenses as well – such as gifts, clothing and entertainment.
Once you have determined how much you spend each month, and therefore how much you can save, set yourself a realistic time-frame to build up the emergency fund and automate the savings plan. If you funnel too much of your money into the fund, and find yourself withdrawing from it frequently you break the “emergency nature” of the account – which is that it should only be drawn from when really needed!
Once you get to one year’s expenses, try to build up to two, and finally three!
Where should you hold your emergency funds?
This really depends on your situation but some general things to look out for
Offset accounts – if your emergency fund sits in your offset account, this can decrease interest on your loan! Be careful if you use your offset as a transaction account, as you don’t want to dip into it!
External Savings accounts: Having your funds external to your normal banking can create a helpful degree of separation, meaning you don’t see the savings regularly. This however, can also mean there is a delay if you need the funds quickly!
Lower income earning account holder: If you’re using a savings account that attracts interest, consider holding the account in the lower income earners name – as interest is taxable!
1 Survey: https://www.finder.com.au/press-release-may-2016-rainy-day-savings
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