Your insurance against life’s uncertainties
If you’ve read the 3 steps to getting started with money, you’re now in control of your money, armed with a budget, focused on paying down your credit card debt and are monitoring your retirement fund.
Now that you’re on top of your money and what you can control, I want you to start thinking about what’s out of your control. Life is full of amazing opportunities but also has a habit of throwing us curve balls we’re not expecting. Mine was my washing machine deciding to break a few years ago and flood the kitchen with a mix of bubbles and lavender smelling water. Yours could be your car needing new parts, a long-term relationship breakdown which means you need to find a new place to live fast.
My family are based around the world and the reality of that lifestyle choice means that if someone happens to one of them, I need to be prepared to drop everything and buy a plane ticket to get to them, whatever the cost as well as keeping up my rent payments while I’m away.
That’s where your emergency fund comes into play. I like to call it my BBEF – my best back-up emergency fund, because like a best friend, it’s there for me when I need it the most and serves as insurance against life uncertainties.
Part of making this choice is defining what an emergency is for you. For me, I can say for certain that a morning coffee or a new work shirt is far from an emergency – these expenses are usually discretionary in that I want them but don’t really need them and they should definitely have already been worked into my budget.
Is a gas bill an emergency? If it’s unexpected, the budget is already stretched and it needs to be paid in order to maintain an essential quality of life, then yes, feel free to dip into your emergency fund. But to avoid that becoming a regular occurrence, examine your bills and start to work these into your budget on a monthly basis to avoid a shock to the budget every few months from the bigger house bills. This also goes for payments like your car registration or tax bills if you run your own business – plan ahead and work these expenses into your budget as you go so that you don’t dip into that emergency fund too often.
And what will help you not to be tempted to access the emergency fund is where you keep it.
Ignore what you’ve seen on TV about people hiding money in their teapot at home – additionally, if you can read this article, you’re too big for a piggy bank. You owe yourself the respect to keep hard earned money in the bank, where in many countries, that money is guaranteed by the Government up to point. In Australia for example, the Government moved to guarantee deposits of up to $250,000 in deposit taking institutions, including banks.
You also need the money to be liquid which means that you can access it quickly when you need it.
A friend of mine put his emergency fund in investments which while prudent in that there was potential for a high return on his money, also meant that it was tied up and not immediately available when he needed it.
What I did was to open a bank account that is completely separate to my day to day account, which I tend to use daily for small purchases that just a tap away. The reason an emergency fund should be in a separate account is so that this money is kept out of sight and you won’t be tempted to touch it until you really need it. I literally opened up an account with a separate banking institution and use this for my emergency fund so I don’t see that money as available to me when I check my day to day account balance. And in selecting that bank, I also chose an account that would grow my money while I slept – my interest rate is competitive and I checked the terms when I opened the account to ensure I’d get the maximum interest rate each month.
But how much do you need to build an emergency fund?
Given a recent survey found that only 40% of Americans could not find $1,000 to cover an unexpected expense, put yourself among the 40% and ensure you have at least $1,000 saved as an emergency fund. Once you’ve hit that target, you can aim for the next target for your emergency fund balance but $1,000 is a great starting point, which is achievable over time for most of us.
You can’t plan for everything and it’s essential for your peace of mind and to avoid emergencies chipping away at your savings goals that you build an emergency fund as an insurance cushion to avoid wipe out from unexpected life events.
To help you get started, I’ve set out 5 steps to building your emergency fund which breaks down what you need to do to get your emergency fund on track.