Money Plan: Emergency Fund
One of the major stresses for many people I meet is to deal with unexpected expenses that come up, that are outside their usual budget. These usually end up either requiring more debt, opening up savings for other items (which can be depressing) or delaying other bills (which can start a snowball of delayed bills), or don’t get paid.
Having a source of money set aside somewhere to pay for those out of the ordinary expenses will give you comfort, and reduce your financial stress.
We call this the emergency fund. It’s a source of funds, either in cash or a bank account that is only there to pay for pre-defined expenses, but otherwise ignored.
The outcome for you of doing this is that you get some peace of mind over your future costs and some more confidence that your day to day plan can be maintained.
If you are fixing your personal financial situation, the first thing I would do after you confirm your budget, is to get an emergency fund.
Ideally you should have $1000. Firstly, it’s a good round number that feels good to have in an account, and feels like a lot more than $999. There are few expenses that would cost more than $1000 that you would have to come up with in a very short timeframe, and if you do, then your whole situation will change.
Now it may be that your situation is so simple (no kids, no car, no appliances or house, and in good health), that $500 is enough, or more complex so that you need more.
Best way to check is to look back at your expenses and what emergencies have come up.
Either way, $1000 is a good place to start.
What constitutes an emergency?
If we don’t set some rules around what constitutes an emergency, then it will be too easy to spend and will likely end up with very little in it, as it gets raided most weeks.
The 4 areas I use are:
1. Medical emergencies – out of the ordinary costs for the doctor, vet, medication etc
2. Family Emergency – flights for a funeral etc.
3. Bill Blowout – for over the expected costs of a WOF or general car repairs, house repairs or Power Bill (also could cover an insurance excess if you need to make a claim).
4. Appliance Emergency – getting the fridge fixed or replaced etc.
You may have a slightly different list depending on your situation, but don’t go past 3-4 items, and if you do make a different list, write it down, call it your rules, and sign it.
How it works:
You ignore the money, and then if an emergency comes up, you access the fund, pay for the emergency and then rebuild the account, by altering your budget.
Why not just have a credit card?
Credit cards are debt, and while it seems like a good idea to use as an emergency fund, you are reinforcing using debt to solve your issues and you then have to pay it back giving you less money for the next emergency.
We want to change behaviours by not increasing debt, and the best way to do this is to use cash.
You will feel better (as good as one can by having to cover unexpected expenses) by having used cash to cover costs than borrowing more (and slowing down your debt repayment plan).
Using a credit card feeds back into the idea of using debt and keeps you in the same behavior cycle. Ideally you should not have a Credit card at all (see other DUX articles on this).
Why save when I have debt to pay off?
Same as the behaviour modifications in the last step. We want your debt only going down, having to increase debt is demoralizing, so we want to avoid this.
Yes you might pay more interest, but if we are changing behaviours to focus on money you have, then its best to stay out of the cycle of debt.
How do I build the fund?
Whatever it takes to get there as soon as possible. At the very least, put aside a good amount of money each pay cycle.
You can also reduce your costs, sell stuff on Trademe, do some ad-hoc work, overtime, get a 2nd job, rent out a room on Airbnb etc.
What if I have goals to save for as well?
The emergency fund is the most important thing to do, it’s worth slowing down other goals to get this. If you don’t have an emergency fund but have money in an account for a holiday and then the car needs repairs, you are going to end up using that money anyway, so better to be formal about it, and have the emergency fund.
Where do I store it?
A bank account that does not have lots of fees to access it is easiest, but you could have a locked container at home, and store it in cash. The bank account is safest though.
How do I keep from spending it?
Ultimately this is up to you, but some things you can do is to name the account on your internet banking, write the rules down for access and keep it somewhere visible. If you need more security, go to a new bank and set up the account there and don’t have an eftpos card for it. Or if you have a family member you really really trust, get them to hold onto the money and give them the rules for access, and tell them only to give you the money when you prove those rules. This could put strain on a relationship, so be careful.
What do I do once I have $1000?
Once you have the $1000, you can either keep saving at the same rate to have a larger fund, or you can reduce the amount, and redirect some of the payment into goal savings or debts.
For example if you are putting aside $50 a fortnight, you may want to reduce to $10 a fortnight when you hit $1000, and put the other $40 into debt, so that the emergency fund grows a bit more. Be careful as this may give you incentive to spend it.
1. Look at your financial situation and determine what level of Emergency fund you need
2. Confirm what your fund rules are
3. Set up the account or where you will store the money
4. Start to save asap to get the money
5. Stay on track.
An emergency fund is the first step towards financial independence and getting out of the debt cycle.
After this we focus on debts and clearing them as soon as possible.
If you would like more information get in touch with the team at DUX Financial and look out for our other articles.