Having an emergency fund is a good idea for everyone as you never know when life is going to spring an unexpected surprise or emergency on you. The following article will outline some tips which may assist you in establishing an emergency fund and why they are important.
What is an emergency fund?
An emergency fund is a pool of money that is set aside to cover any urgent or unexpected costs. This could include car repairs, unexpected travel, or any urgent medical costs due to an unexpected injury or illness that may arise.
Why is it important?
Emergencies and unexpected costs can arise when you least expect them and often incur additional stress or take an emotional toll when they do. That is why it is crucial to set aside a cash reserve to give you peace of mind that you have will have sufficient cash flow to cover the cost of an emergency whilst still meeting your standard expenses such as living and rent expenses or mortgage repayments. Having this financial safety net will not only put your mind at ease but will mean that you do not have to compromise on your other financial needs and objectives if an event arises where you need additional cash flow.
Another consideration as to why having an emergency fund is essential, is that having insufficient cash flow may result in you needing to borrow additional funds either from friends, family or adding to existing levels of debt you currently have. Increasing your levels of debt during an emergency will increase the stress you are under and may delay other financial objectives from being reached in the future.
Therefore, it is important that all individuals consider growing an emergency fund, and although this takes time, discipline and potentially some short-term sacrifices, it will assist you to weather the financial challenges that life throws at you.
How much do I need?
Something is always better than nothing; and thus, putting away a small amount each week or every time you are paid is a good start to building up this cash reserve. Although it may feel like $20 a week would make no significant impact, if you did this every week for a year, you would have $1,040 by the end of the year. This provides you with some leeway if an unexpected expense arises as you continue to build your emergency fund.
The general rule of thumb for a cash reserve is to have enough money to cover three months of expenses. Therefore, this amount with vary from person to person depending on your current income streams and your subsequent expenditure.
If you know that down the track you are likely to need more than this, including to use when taking time off work to care for a family member, you may want to allocate additional funds to build this up.
How do I set one up?
- Set up a separate savings account
It is a good idea to separate your emergency fund from your everyday account. It is also a good idea to find a high-interest account that will assist you with building it up. Some accounts may reward additional deposits with bonus interest and this is something you may want to ask your current provider about. Having a separate account will also reduce the likelihood that you will use the cash for a short-term expense which will reduce how quickly you build your account balance – out of sight, out of mind.
- Automate your savings
Another tip that may assist you is to set up automatic withdrawals from your regular everyday savings account to allocate a stipulated amount and deposit it into your separate savings account. This will allow for your emergency fund to build up in the background without even noticing the money is gone and means you do not have to remember to withdraw it every month. Alternatively, you may wish to ask your employer if they can deposit a set amount of your wage into your separate savings account. This way you can set and forget!
- Maximise your offset account
If you currently have a home loan with an offset account, you may wish to use this account as your emergency fund. The result of this is that it will lower your home loan repayments and allow you to access your money quickly.
- Make additional deposits
If you receive additional cash flow throughout the year such as a bonus or tax refund, you can use this to boost your emergency savings.
- Look for ways to cut expenses
It may also be a good idea to review your current expenses and consider reducing unnecessary expenses. This could include subscription services you rarely use, which will assist to free up additional cash for your emergency fund.
It is also important to define what an emergency means to you, which should be different from other forms of savings you have for a ‘rainy day.’ This will help to prevent you from dipping into the fund in circumstances where you want to have additional funds, but may not be an emergency situation.
You never know when life will throw you a curveball and therefore it is a good idea for everyone to have an emergency cash fund to help you weather the storm. If you would like additional guidance concerning your cash flow or current investments, please click here to organise a complimentary 20-minute phone call with an EPG Wealth adviser.