Lesson 4.2

5 small steps to build an emergency fund

We’ve all had those moments in life where something goes wrong and it’s looking like it’s going to be rather expensive: the car needs new tyres, or your washing machine breaks down.

Where are you going to find the money to fund those expenses? In times like these, it can help to have an ‘emergency fund’.

An emergency fund is simply a separate account into which you put some savings to act as a buffer in your life. Sometimes people call it a rainy-day fund, or a ‘what if’ fund.

Many finance experts recommend having 3 to 6 months of your living expenses saved in an account you can easily access in the event of a job loss or other significant expense.

That can sound intimidating, particularly when you’re starting from scratch. So here are five small steps you can take now to get you started on your journey to building your emergency fund.

Step 1. Know why it’s important

Having an emergency fund is a good idea because it can help you avoid going into debt to fund an unexpected expense. Alternatively, it could help you avoid having to sell an asset, such as shares, to fund the expense at a time which might not be opportune, for example when the share market is down.

An emergency fund can also provide you with an important sense of freedom that you could change or leave a job - or a relationship - if you ever wanted to. 

Step 2. Decide how much you want to save

While many financial experts recommend having 3 to 6 months of living expenses saved up in your emergency fund, the appropriate amount can vary. Some people may want a bigger safety net to feel comfortable.

For others, a smaller amount may be more realistic – at least initially. If you are starting from zero, even setting a small goal amount, say $500, is a step in the right direction. Once achieved, you can then work up to $1000 and beyond.

Ultimately, it’s about determining what amount helps you sleep at night - what helps you to feel protected in your life to enjoy the peace of mind that an emergency fund can give you. 

Step 3. Open a separate account for your fund

One of the key things about an emergency fund is that you need to keep it in a place where you can access it easily.

What type of account you open depends on your personal circumstances. It could be an at-call online savings account. Or, if you have a mortgage, you could use an ‘offset account’ where your emergency savings balance will offset your home loan balance, reducing the amount of interest you pay.

It can help to give your emergency fund a fun name that is personal to you, such as ‘my sleep well at night fund’, and, if available, opt to ‘hide’ your account from the list view of accounts in your banking account to avoid the temptation to spend money from it. 

When managing your accounts, consider your personal circumstances and manage your accounts in a way that is appropriate and safe for your situation.

Step 4. Know when to use (and replenish) your buffer

It’s important that you maintain good hygiene around when you do dip into your emergency fund. An unexpected medical bill or car repair are good examples of what an emergency fund might cover.

A new pair of shoes, or that cheap deal on flights, are generally not. Future you will thank you for protecting your emergency fund for genuine emergencies.

If you do end up drawing down on your funds, work out a plan to replenish and restore your fund to your desired amount.

Step 5. Review your fund size regularly

As life ebbs and flows, be sure to keep checking in with your emergency fund to ensure it is appropriate to your needs. Changes in your life circumstances, such as having kids, getting a pet, taking time out of the paid workforce, buying property and current living expenses can all change the amount you might like to have saved for emergencies.

Keep building and maintaining your emergency fund overtime. It’s there to protect you and give you confidence to handle whatever life throws at you.