What is an Emergency Fund and why you should I have one?
We’ve all been there: your car breaks down, you lose your job, your heating system blows up on the first day of winter. Life happens.
When ‘blowout’ events occur, they can not only throw your financial goals off track, but also create a huge amount of stress –some of us will have an elevated pulse just reading the words emergency fund!
According to a recent study by BT Financial Group, one in five Australians have no savings to fall back on and would struggle to pay for an unexpected $500 expense without selling something or borrowing money.
If you’ve completed the second step on Money Management in the Verve Academy Money & Mindset program, chances are you’ve already heard our Head Coach, Zoe Lamont banging on about safety buffers. There’s a good reason for this: building a safety buffer can be one of the most important steps for you to take control of your finances and build peace of mind.
Safety buffer, rainy day account, back up or emergency fund – it doesn’t matter what you call it, whether you earn 30K a year or 200K, you need to have one.
But how much do you need to save into an emergency fund? What should you do with the money? And when is the right time to withdraw it? Here are our top tips to building a buffer.
How much to save in your back-up fund
At Verve, we typically recommend that over time you set aside between three to six months’ worth of living expenses for a back-up fund. That is, 3-6 x what it costs you to live each month. This usually includes keeping a roof over your head, food on the table and managing any debt repayments or financial commitments. That can sound like a really big number… but this is the heart of financial self care. It’s ok if it takes some time to build.
The exact amount that you need to put aside for a rainy day (or a rainy season) should be based on your unique personal circumstances.
When deciding your target for a back-up fund there are three important factors you should consider: (i) how stable is your financial position, (ii) what is your personal comfort level with risk, and (iii) what other financial safety blankets you have in place (i.e. insurances or a partner’s/family members’ financial support).
For example, if you freelance full-time and you’re a single mum (or dad) without income protection insurance (note: it may be an idea to consider insurance!) and no safety back up financial support from a partner or family member, then you’re probably going to want closer to six months’ (or more) worth of expenses saved up. (By the way, we salute you and know that you’re most likely already a master money prioritiser!). If you have a stable job, share household expenses and living costs with someone (like a spouse), have all your insurances in place and have no dependents and no mortgage, three months is probably more than enough for you.
As you plan what should be in your backup fund, take a moment to think about how you would fair financially if not one but several unexpected life changes were to happen in close succession. You lose your job and a week later your car engine blows up – there’s a reason that people say that things go wrong in threes.
Set a goal that feels right for you. Once you reach your target buffer (kudos to you!), keep that savings habit going and have a think about how you can invest the rest of your savings for higher growth— here’s why.)
Once you’ve set your ideal emergency buffer saving goal, we have four quick tips to help you see that savings buffer grow.
1.Pay down any high-interest-rate debt first
As a rule of thumb, anything that you are paying more than 5% interest on— before you get started. (Not paying that debt off can really cost you, so do that first.)
2. Consider opening a separate savings account
Just for your buffer, so that the money is not mixed in with your day to day spending account -and you can’t easily access it if you’re in the mood for a splurge.
3. Decide how much you are able to put away each fortnight or month
We advise setting up an automatic transfer so that the money is taken out when you get paid.
4. Set mini-goals along the way
It may take you a few months, or a couple of years to reach your goal. Maybe your first goal is just to have $500 put away, and then work towards one month’s expenses.
Where to hold your back-up fund
When you need your emergency fund, you will need the money urgently, after all, the money is for emergencies.
So keep your emergency fund in cash (we’re talking in the bank cash, not under the bed cash). We don’t recommend putting your emergency fund in shares or any other type of account that doesn’t let you make withdrawals whenever you want, or where you could lose money if you need to do a hasty drawdown. Don’t risk it.
However, do hunt around and find a high interest savings account, you will hopefully end up with a decent size pool of money in this account, so you may as well be earning interest on the money.
If you have a home loan, putting this money in a mortgage offset account, could be a great way of reducing the interest you are paying on the loan, just make certain you can easily withdraw the money when you need.
When to use your back-up fund
This should be easy: in an emergency. And no…. that holiday you ‘urgently’ need to take doesn’t quite cut it, sorry!
Is this a want or a need. Base your decision on whether you absolutely need to pay for the expense now or whether you can save to pay for it later. Good examples are traveling to see a loved one who is ill, or covering day-to-day living costs if you suddenly find yourself unemployed.
Saving up three to six months’ of living expenses, in cash, for emergencies only, is a great way of taking control of your finances, and will bring most people some good peace of mind. To learn more about establishing a money system to work for you and your money goals check out the Verve Academy Money & Mindset module on Money Management. We’ve got you.
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