I’ve been reading a lot about emergency funds lately. Apparently it’s one of the building blocks of a really good financial plan.
It was a relatively new concept to me. But given I have funds stashed away for a rainy day, maybe it’s just the label that is new!
What is an emergency fund?
An emergency fund is an account or amount that you have for “emergencies”.
The concept of an emergency fund comes from the premise that everybody is somewhat vulnerable to job loss and uncertainty with their income. This type of fund is a little different to the everyday emergencies, those unexpected expenses and the normal ups and downs of living.
The idea is that when the funds are flowing in, some of these should be put aside for that day when the funds aren’t flowing in. Different to superannuation which is accessible in retirement, an emergency fund is for when the chips are down and there is nowhere else to go. You have bills to pay, hungry bellies to fill and the money has to come from somewhere.
Once you’ve built your emergency fund up its pretty much set and forget (hopefully on a good interest rate). If life is good to you and you don’t touch it, it’s a nice little addition to your retirement income.
Of course it’s also important to have the income or a fund for other unexpected expenses when they arise. The reality is, if the money is in your emergency fund you can use it and top it back up as soon as you can. Alternatively have another account for unexpected expenses, as they tend to keep arising (at least in my household!).
How much should I have in an emergency fund?
That really depends on what works for you. Maybe a bit on who you listen to. I’ve heard suggestions from one month’s salary through to one year. There are a few things to consider that might help you decide what is best for you.
- How much do you spend on living each month?
- How long would it take you to find a new job?
- Do you have income protection and any other risk insurance products?
- What are your essential expenses and what could you cut out if money was short?
Understanding your budget will help
By understanding your essential living expenses without all the luxuries and lifestyle choices on top, you may shave an amount off the figure you decide to aim for.
If you decide you want to save six month’s salary, you may decide to work out your “essential budget” and save six months of that instead.
Do you have an emergency fund? Please share in the comments below.
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