An emergency fund might be one of the least exciting but most powerful types of savings you can have. It’s that good old-fashioned rainy-day fund that you know you should start, but probably keep putting off.
Your emergency fund provides money for unexpected life stuff and can boost your mental health simply by giving you the confidence of knowing that you’re prepared for what life might throw at you.
Read on to see a few reasons why this safety net is important and the steps you can follow to set one up.
What’s the purpose of an emergency fund?
As the name suggests, an emergency fund isn’t for overseas holidays or wardrobe updates (that’s a different fund). Instead, it’s usually for unanticipated expenses that you need to cover quickly, such as:
- Medical or dental bills
- Urgent home repairs
- Car repair costs
- A temporary loss of income
- Emergency travel
- Repairing or replacing essential equipment like a laptop
Your emergency fund depends on your lifestyle and responsibilities and often will grow with you as your life changes.
For some people, an emergency fund might help them to get out of a tough spot like choosing to quit a toxic job without another one lined up or moving on quickly from a bad living situation.
Without an emergency fund, you might need to tap into your long-term savings or take out or extend a loan to cover these unanticipated costs.
How to build an emergency fund
1. Set up a new account
By setting up a separate bank account for your emergency fund, you’ll be able to see how much is in it and be less tempted to dip into it for reasons other than urgent costs.
A savings account that pays a higher interest rate, like our Save up account might be a good option for you. You can access funds anytime but also reap the benefits of a bit of extra interest if you save regularly and don’t need to make withdrawals.
2. Establish a target
It’s hard to know how much you might need in the future for life’s unanticipated events; however, having a ballpark figure in mind can help keep your savings on track.
Consider what your priorities are. For example, do you need your car for work or could you live without one for awhile? Or would you need to travel to care for a family member at short notice?
You should align your emergency fund to these things and start building up a pot of savings that can cover your basic expenses.
MoneySmart suggests putting aside three months’ worth of living expenses. How do you know what that amount is? The easiest way is to work out your budget. We have a budget planner on our website you can use to see what this may look like for your household.
It’s difficult to be prepared for every single eventuality, but some level of emergency savings is always going to be better than nothing.
3. Think about regular payments
The thought of saving up three months’ worth of living expenses might seem overwhelming but it doesn’t need to be. Simply starting to set aside a small percentage of your income is a great step in the right direction. If you’re starting from scratch, consider making a payment to your emergency fund each week, fortnight or month.
If you put aside $20 a week, you’ll have over $1000 in a year’s time. That’s the start of a good amount of savings to give you some financial breathing space.
You may even wish to automate deductions from your main account to your separate bank account, so you don’t have to think about it.
4. Consider adding any windfalls to your emergency fund
Adding a larger payment can help build the fund up quickly., so if you get a pay rise, inherit some money or receive a tax refund for example, consider directing some or all of it into your emergency fund.
5. Set up some rules for tapping into the fund
To keep enough money in your emergency fund, so it’s available for its intended purpose, it’s important to establish some ground rules around how and when you’ll use it. For example, you may wish to pay for smaller car repairs or dental bills from other accounts to avoid eroding the savings in the fund.
We all have ‘surprise’ expenses from time to time, but when we’re hit with an especially large, unexpected cost, it can quickly threaten to blow out the budget and cause real financial stress. By setting up an emergency fund today, you and your family will be in a better position to cope financially, if an unexpected cost comes along tomorrow.
Please note this information does not take into account your personal circumstances and is general advice only.