Life happens and sometimes that means having to fork out a chunk of cash for an emergency. Before reaching for a credit card or being tempted by a personal loan with fast approval, preparing for the unexpected with an emergency fund allows you to plan for specific situations should they happen to arise.
What is an emergency fund?
As the name suggests, an emergency fund is money put aside specifically for emergency purposes. This differs from a day-to-day expenses or a transaction account where you pay for routine bills like electricity, internet, groceries, and car servicing. Depending on your situation the type of emergency may differ, however emergency funds are typically set up for:
- Job loss
- Illness or medical emergencies
- Carer duties
- Emergency repairs (car or home)
- Otherwise unexpected hefty bills
What are good options for an emergency fund?
Savings accounts are the most common option for emergency funds given they are simple accounts that hold your money, cost nothing (if no fees are in play) and continue to grow through the power of compound interest. It could be wise to separate this account from your other savings goals - such as house deposit or holiday fund - so you're not tempted to dip into it. A savings account with relatively few conditions might also be advisable, as you want to accrue interest on a chunk of cash without having to deal with the rigmarole of minimum deposits and transaction requirements.
Credit cards present a quick and easy way to stretch the household budget to cover small emergency expenses. Some credit cards offer up to 55 days' interest free on purchases, depending on when in your statement cycle you make the payment. In this case, you might want to opt for a basic card with no annual fee so you can keep costs down. However, if your family emergency requires a significant amount of money to be spent, it's important this is factored into consideration in terms of repayments as interest will accrue. And interest can be hefty if the balance is not paid off within the specified period. A low-rate card could be a suitable option, however keep in mind other featurs will likely be limited.
How much do you need in an emergency fund?
A general rule of thumb is to build your fund so you have about three months' worth of living expenses as an emergency buffer. This will allow you to continue to cover costs for about three months in case of a sudden loss of income or unexpected expenses. The theory is that three months is a lengthy enough period for the emergency to settle and to find your feet. However, your first point of call is to analyse your income, expenses and outstanding debts and aim to put aside one months' worth of living expenses in an emergency fund. This might be a more attainable goal. There is no 'perfect answer' when determining how much money you need to put aside in an emergency fund as individual financial circumstances can vary significantly. It's important to consider your unique circumstances, such as your income stability, monthly expenses, and any debt you have, when determining the right amount for your emergency fund. If you have a high level of debt or a variable income, you may need to have a larger emergency fund to feel financially secure. Ultimately, the goal of an emergency fund is to give you peace of mind and the financial cushion to weather the storm of emergency expenses. Start by saving what you can and build up your emergency fund over time - it's not a race after all.
How to maximise your savings in an emergency fund
1. Automatic transfers
If you are using a savings account as the sensible option for an emergency fund, banks will typically offer the ability to set up an automatic transfer to your emergency fund from the account that your wage is paid into. This will allow you to set and forget, knowing your emergency fund is growing without too much effort on your behalf.
2. Utilise an offset account
If you have a home loan with an offset account, you can use the offset account as your emergency fund. This will lower your home loan interest payments and means you can access your money quickly. An offset account will also save you in interest costs, and sometimes saving interest can be better than earning interest.
3. Avoid the temptation of dipping into your emergency fund
If you are ever short on cash on a night out, it can be tempting to dip into your emergency fund to help you get by. Making a conscious effort not to use your emergency funds for non-emergency purposes can help build the balance at a faster pace. A good way to tackle this temptation is to have a separate account and to not keep the debit card in your wallet so you don't dip into it.
4. Keep adding to your emergency fund
If you get some extra money during the year, like a tax refund, you can use this to boost your emergency savings. If you have no emergency fund whatsoever and no debts to pay off, it could be wise to direct all your savings to the emergency fund (or whatever is manageable) so you can build the balance quickly.
5. Shop around for high interest savings accounts
Compare savings account rates using InfoChoice's savings rate comparison tables and look to take advantage of an account that offers high bonus or introductory interest rates to maximise the growth of your emergency fund. Life throws everyone an unexpected event occasionally. Having a steadily growing emergency fund set aside could make all the difference when you need it most.