So what’s an emergency fund?

An emergency fund is money set aside for life’s unexpected events. I am sure we’ve all be hit with one of life’s curveballs such as having to repair a broken air conditioner in the middle of Summer… or our car refuses to start… or maybe if have a family emergency and need to travel to see them.

Why is an emergency fund important?

You don’t have to look too far to see the effect of suddenly becoming unemployed or having reduced work hours. The current headlines (March 2020) depict the impact the Coronavirus pandemic has on the broader economy, with job losses in the education, tourism, hospitality and arts industries (and many more). 

You might be thinking “well, this sort of thing is unprecedented – how could I have seen this coming?!” – And I would agree with you. An emergency fund doesn’t make you suddenly immune to economic crises, but it puts you on better footing compared to if you didn’t. We all have bills to pay, and a good majority of us have loans or credit cards to repay as well. Having an emergency fund helps cover you in the event of an unexpected financial/economic event, helping you avoid having to borrow money and go further into debt.

I used an example based on current affairs, but there would be more reasons you’d consider an emergency fund. For example,

• What if you own your home and there are unexpected repairs? 
• What if you require urgent medical attention? (e.g. sports or workplace injury, or emergency dental work)
• What if you need to suddenly travel abroad due to a family emergency? 
• What if you do freelance work (i.e. income can be unknown and cyclical) 

How much do Australians save?

I came across this tweet (Source: Grattan Institute) a few days ago, and it was actually the inspiration for this particular blog. 

The analysis was undertaken a few years ago, but the narrative hasn’t changed. Yes, I know there are a lot of caveats to this data analysis. This chart shows bank balances only (i.e. doesn’t include other assets such as shares or bonds), and is for working households which may also include your partner or other persons living with you and generating an income.   

Looking at the chart above, completely disregarding your lifestyle and living expenses, where do you currently sit? It is actually a scary thought that the median household has only $7,000 in their savings account! How long could your household survive on $7,000? If you’re single with no dependants, that answer might be a few months. On the other hand, if have a bigger family then maybe $7,000 won’t last you as long…

The data suggests that many Australian households are dangerously close to ‘living paycheck to paycheck’ with little to no emergency savings – this is a huge concern given the current economic climate we’re facing. The situation we’re living in now demonstrates the importance of having money in an emergency fund.

How much do I need to keep in my emergency fund?

As with most things in life – it depends on your circumstances. What is commonly referenced within the personal finance community is anywhere between 3 to 12 months’ of ordinary living expenses. One month of ordinary living expenses would include cost for basic needs such as food, utilities, rent or mortgage, and transport costs such as fuel or a Myki (public transport ticket) – How much would you need to spend per month to cover the basics?

You might have a gut feeling based on experience, which is a great start! In a future article, i’ll show you how I determine my monthly expenditure based on historical spending, and then use these insights to generate a budget.

Should I choose an emergency fund with 3 months? or 6 months? or 12 months?

You might consider keeping a smaller emergency fund (three months) if you are currently living at home with your parents, saving up for a major purchase, or maybe you are working in a relatively secure industry. On the flip side, 12 months’ of expenses as savings might be ideal if you have dependants, work on a job reliant on commission-based earnings or in a high-risk industry. Working in the business industry, a suitable to me would be “If I lost my job today, how long would it typically take for me to get another job?” 

The main point is, set an emergency fund amount that will most appropriately cover you for when the unexpected happens. 

So, where should I keep my emergency savings?

As unexpected events hit before you even have time to rub your eyes, your emergency savings should be kept in a place that can be withdrawn (and used) as soon as practicable, such as a High Interest Savings Account (HISA) or an everyday transaction account. I would also recommend keeping this money separate from other funds, so there is less temptation to transfer money away from your savings. As the old proverb says, “out of sight, out of mind”… well until you need it!

Your emergency funds are no good to you if they are in the form of shares or bonds, or in your superannuation as they are not as easily converted to cash, compared to savings in a bank account.

You’ve convinced me, but how do I even start?

1. Understand your situation and determine a suitable level of emergency funds (generally 3 to 12 months’ of expenses). 
2. Determine the total amount your emergency fund requires
   • If your monthly living expenses are $2,000 and you are aiming to have a 12 month emergency fund, then your total is 12 x $2,000 = $24,000 in your fund
3. Set up a strategy for building up your emergency fund
   • You might already have the amount you need – hooray, great job! Make sure you aren’t putting all your money straight into the emergency fund – remember, we don’t want to have to  dip into this money unless real emergencies happen.
   • For those of us that don’t, we could put aside a portion of our savings each month to slowly build up the emergency fund over time – I’ll provide more information on this in later posts around budgeting!

Other considerations:

• The emergency fund is for unexpected events only. Don’t use this money just because you want to buy a new Macbook or the Animal Crossing video game that just came out! This sort of spending is what I call ‘Fun Money’ is comings from a different bucket of savings – more in this in future blogs.
• If you draw from the fund, think about how you’ll replenish this buffer as well. We want to keep this buffer topped up at all times!
• If your situation changes, consider revising your emergency fund savings amount. A good example of this would be if you have a newborn, your living expenses might start increasing.