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28
Feb 19

What is an emergency fund?

by Lachlan Hayes
What is an emergency fund

I’m sure most, if not all of us have been caught off guard by an unexpected bill; maybe your car has just broken down, you’ve injured yourself, or a pipe suddenly bursts at your home. Aside from dealing with the inconvenience, you now have to fork out some of your hard earned cash to pay the bill.

The pressure and panic that comes from suddenly being faced with a large bill that you weren’t expecting is never a fun experience. So how you can stop it in the future? An emergency fund could give you the peace of mind that if such a cost were to come your way, you would have the funds ready to pay for it.

What is an emergency fund?

An emergency fund is simply a stash of money that you have saved up, specifically to cover unexpected costs. Whilst you may already have a savings account, having an emergency fund set up as well means that you don’t have to dive into your holiday or savings fund when the unforeseen happens. An emergency fund should only be used for large costs that you didn’t see coming such as:

  • Expensive car repairs
  • Covering your living costs during sudden unemployment
  • Medical costs not covered by insurance
  • Home or home appliance repairs
  • Large fines

A good rule of thumb for determining whether or not something warrants using your emergency fund is; if you’re surprised and frustrated about that cost and can’t afford it, you should probably use your emergency fund. The flip side to this is that you shouldn’t use your emergency account to buy groceries or some new clothes (unless you’re suddenly unemployed).

Why should I have one?

An emergency has a few advantages. In addition to the peace of mind that you won’t be caught off guard by an unanticipated cost, an emergency fund is absolutely key in preventing you from finding yourself trapped in a debt cycle. It’s fairly common that when people get hit with an unexpected bill they turn towards a credit card or payday loan for relief. This can snowball the expenditure out of control when interest is thrown into the mix and it can drag out the time it takes to pay off, setting you back even further when the next bill appears in your letterbox!

How much should I have?

It’s generally considered that if your emergency fund can cover your living expenses for three months, you have enough and can probably stop contributing to it. That doesn’t mean you have to though! Now, you might think that’s a lot of money to save up, and it certainly can be, but you don’t have to contribute to it all at once - start with a small amount, even if it’s just $20 a week you’ll have over $1,000 saved up in a year (given there are no hidden costs to deal with before then)!

How can I start?

  1. The first thing to do is open a new bank account to keep your emergency fund separate from your day-to-day spendings. To keep the money accessible for when you really need it, opt for a savings account as a term deposit may restrict you from accessing your funds when you need them most. If you have a mortgage with an offset account, you could use that as your emergency fund and enjoy smaller mortgage repayments and potentially reduced interest!
  2. Take a look at your budget. You want to determine a reasonable amount that you can tuck away into your fund – if you aim too high you might get discouraged, or too low and you might not have enough put away, so choose a savings goal that you can genuinely afford.
  3. Now you have everything you need to build up your emergency fund, it’s time to get going. Set a reminder to transfer money from your everyday account to your emergency fund. You could even set up your bank account to make the transfer automatically!