Why have a pile of cash that you cannot spend just sitting in your bank account?
Because Murphy’s Law dictates that the day you lose your job, your car will break down AND you’ll chip your tooth on your Snickers bar (requiring a painful and expensive trip to the dentist). Bad things happen (usually all at once) and having cash available means you don’t have to beg, borrow or steal your way out.
Pretty self-explanatory: it is an amount of cash that you have saved for unforeseen or ’emergency’ expenses. The aim of an emergency fund is to avoid having to go into debt for a cost that cannot be avoided, for example:
Personal insurance, like trauma cover or income protection, will only cover you under certain conditions that affect your health. Income protection can help you if you are unable to work due to illness or injury. Your insurance company does not want to hear from you if your 10-year-old dishwasher finally breaks down.
Another consideration is that many insurance policies include a waiting period (the most common of which is 30 days) and they are paid in arrears. This means that even in the event of a successful claim, it may be up to 60 days before you see any of that money. What are you using to pay your bills and buy groceries in the meantime?
The fact that most Australian adults now have easy access to credit cards has allowed people to avoid having an emergency fund. But remember – the aim here is to avoid going into debt when something unforeseen happens. That includes credit card debt! Many clients come to us because they have become stuck with credit card debt with high interest rates. That short term use of a credit card can end up as a long term loan costing thousands of dollars in interest.
An emergency fund does not just prepare you for a rainy day – it gives you options, reduces your risk and helps you sleep better knowing that your financial emergencies do not have to derail your future.
Ideally it wouldn’t be a case of one or the other, but all three. Paying down your home mortgage is vital in building a strong financial foundation, but that doesn’t mean that you shouldn’t be setting some money aside every month as well.
If you want to save up a cash fund, but also pay off your home loan, you should consider an offset account. Money in this account completely offsets your home loan principle and reduces your home loan interest. It’s a great way to accomplish two financial goals in one account.
In many ways, your short term needs are more important than your long term needs – simply because you have time to prepare for your long term needs. The nature of an emergency is that it is unexpected, urgent, and requires immediate attention. If you are not prepared for them, then you will be stressed and worried about the short term problem rather than focusing on the long term solution.
The old ‘rule of thumb’ that many experts suggest is three months salary (yes, we mean your and your partners combined salaries). However, the more relevant calculation is how much you would need to cover your living expenses for three months (including mortgage, loans, groceries and bills).
If you are highly unlikely to be out of work at the same time as your partner (i.e. you work in different industries or one of you is self-employed) then you can take this into account. Similarly, if you have comprehensive insurance that will cover you for some emergencies, you may also be able to get by with less. On the flip side, if you have a decent emergency account, you may not need as much insurance. This could be a great way to reduce your premiums (why not increase your waiting period on income protection)?
“Use your common sense and come up with a number that you and your family are comfortable with. Even as little as $2,000 sitting in a savings account will go a long way to relieving some financial stress involved in unexpected costs.”
Remember that this is your emergency savings, not your emergency investments. Emergency funds need to be liquid, easily accessible and have no risk of short term loss.
None of this short term money should be placed in the stock market. Instead, put it in a savings account or offset account where you will not be tempted to spend it, but will have easy access when you do need it. If you are easily tempted, it may be worth opening an account with a different bank.
If you are struggling to save money consistently, you would benefit from the Fortress Wealth Hub which automates the budgeting process and helps you identify ‘where’ your money is going.
Many ’emergencies’ are not actually emergencies, they are foreseeable costs that happen unexpectedly*. For example, the need for a new car every 5-10 years is foreseeable (you don’t know when your car will breakdown, but you should know roughly how long it will last).
Think through all the potential expenses that might come up in the next few years (new car, washing machine, holidays etc.) and make sure you have enough savings for them. This type of money should be saved based on a financial plan or budget. If you know you will need $10,000 for a new car in 10 years (based on the car’s life expectancy), then you can save $1,000 per year to reach that goal. Even if your car breaks in year 9, you will be much closer to your ’emergency’ need than if you had not planned at all.
So that you don’t confuse these foreseeable expenditures with true emergencies, you should always create a list of acceptable expenses that the money in your emergency fund has been designated for. This will also avoid family arguments – if it is not on the list, then the money isn’t touched.
Finally, once you have gotten back on your feet, don’t forget to build your fund back up again so you are ready for the next emergency.
If you would like to start saving an emergency fund or like more information about the Fortress Wealth Hub but don’t know where to start, please contact us to book in a free consultation on 07 4646 4970 or at email@example.com
Written by Emma Linton Doig, Practice Officer at Fortress Financial Solutions
Corporate Authorised Representative of Magnitude Group Pty Ltd ABN 54 086 266 202, AFSL 221557.
Information on this site may be regarded as general advice. That is, your personal objectives, needs or financial situations were not taken into account when preparing this information. Accordingly, you should consider the appropriateness of any general advice we have given you, having regard to your own objectives, financial situation and needs before acting on it. Where the information relates to a particular financial product, you should obtain and consider the relevant product disclosure statement before making any decision to purchase that financial product.