Your car breaks down on a quiet road. Your fridge calls it quits a year after the warranty expires. A sudden family emergency means unplanned travel. Life loves to throw curveballs our way – and let’s be honest, it happens to all of us.
If unexpected situations arise and you’re unprepared, it can be a real struggle to bounce back without a financial safety net.
So how much money do you need for your safety net, and how do you build it? Here are our tips on how to set up your emergency fund and plan for the unplannable.
What is an emergency fund?
An emergency fund, also known as a rainy-day fund, is an amount of money strategically set aside to provide immediate financial support when an unforeseen emergency arises.
Say your car breaks down unexpectedly, and the repair bill totals $2,500. Emergency savings can come to the rescue, absorbing the financial shock, and sparing you the need to borrow money.
Without this safety net, you might find yourself taking one unwanted debt and facing financial strain for a long time to come.
What qualifies as an emergency?
Knowing what constitutes an emergency will help you avoid frivolous use of your fund, and ensure you’ve got enough cash ready to go when a genuine emergency unfolds. A well-rounded rainy-day fund should be able to handle:
- Unexpected home repairs
- Sudden breakdowns of major appliances
- Medical bills that surpass your initial expectations
- Job loss or a significant dip in income
Note that big, recurring expenses that you can plan for – such as car registration and servicing, and dental visits – should be accounted for in your regular budget. Likewise, you should factor other irregular but costly events, like weddings and birthdays, into your regular budget to prevent them from wiping out your emergency savings. (Check out our step-by-step guide to creating a budget if you need a hand).
If you do need to tap into your emergency cash, be sure to pay it back at the earliest opportunity, so you’re always prepared for what’s to come.
How much money should be in my emergency fund?
You can’t predict the unpredictable, but a proactive approach is your best bet for building an emergency fund.
Start by listing all the potential scenarios that might tap into your rainy day fund. If your trusty air conditioner bids farewell, calculate the cost of its replacement. If a family member lives overseas and you receive news of an emergency, work out a ballpark figure for how much a last-minute flight would cost to be by their side.
A realistic goal is to set aside a minimum of one month’s worth of expenses for your emergency fund. Take a look at your budget to determine how much you’ll need – that’s the minimum amount that covers your current lifestyle (use our handy Budget Planner Calculator to help determine this number).
Once you’ve reached this amount, keep building your fund until it covers about three months of living expenses. This should provide you with enough breathing space if an emergency strikes.
Emergency savings vs insurance
While it’s comforting to know your emergency fund can cushion unexpected financial blows, some losses are beyond its scope. Consider insurance to protect your bigger assets.
If you own your own home, home and contents insurance could be invaluable; likewise, for our furry friends, pet insurance could be a literal lifesaver. While it’s tempting to weigh the cost of insurance against potential savings, consider this: could you genuinely afford to replace the item or cover its cost from your savings if the unexpected occurred?
Insurance can be complex so make sure you read over all the terms and conditions, exclusions, and limitations to ensure you aren’t caught without coverage when you need it most.
Where should I stash my emergency cash?
An emergency fund is different from regular savings and should be kept in a separate bank account so you don’t accidentally dip into it. Opt for a high-interest savings account – this way, your funds will grow faster and your discipline will be rewarded over time.
You can automate the process by setting up regular transfers from your everyday account to your emergency fund, or ask your payroll department if they can pay a small portion of your wage directly into the emergency fund account.
You can give your emergency fund an annual boost by allocating any extra funds you receive to it, such as a bonus or your tax refund, providing you with even more peace of mind.
While reaching your savings target may take time, every dollar tucked away is a shield against.