What is an emergency fund?

Find out how an emergency fund could help you bounce back if the unexpected happened.

Here's what you'll find out:

➜ Why an emergency fund is important

➜ How to build an emergency fund

➜ Ways to manage your emergency fund

An emergency fund is money that’s set aside to cover financial emergencies. A financial emergency could be something like:

  • Losing your job
  • Becoming unwell for a long period of time
  • Having to take time off work to care for a relative

It’s not nice to think about, but having money set aside for events like these will mean that you won’t have to borrow money and be charged interest. Having to borrow money to get by can make a bad situation even worse.

How to build an emergency fund:

1. Figure out how much you spend a month

It’s generally recommended that you have around 3-6 months’ worth of living expenses in an emergency fund.

Looking back at your transactions for the last 3 months, total up how much have you spent. Once you have that total amount, work out the average you’re spending per month.

2. Set yourself a goal

Now you have your average monthly spend and you want to have 6 months’ worth of living expenses in your emergency fund, you can now work out your ultimate goal. It might be a pretty large amount, so don't be daunted - you can work towards it over a period of time.

While it’s helpful to know what you’re aiming for, it’s probably going to be more beneficial to break this down into smaller goals. Perhaps you could try target amounts of 1, 3 and 6 months?

3. Create a timeline

Looking at your budget, when would you be able to save enough to meet your target amounts? Use this timeframe to set yourself a plan and write down what you’ll have saved by when.

Remember to be realistic with the amount you’ll be able to save per month. It would be great to reach your goal sooner, but you don't want to cut down on your basic necessities to achieve it, slow and steady really can win the race.

4. Think about where you keep your money

Ideally you should be able to separate your emergency fund from your everyday spending money. This will mean you’ll have a clear idea of how much you have saved at any time and also reduce any temptation to spend.

Even though the money may be in a separate account, you need it to be easily accessible. If you lock the money away for a set period of time you may be penalised for accessing it. So think about choosing an account that rewards you for savings by paying interest, but also won’t charge you if you need to access the money quickly.

If you think it will make things easier, you could direct debit an amount from your pay so that the money is instantly transferred into the account and separated from your everyday spending.

5. Keep checking in

As you go, keep checking in to make sure you’re on track. If something isn’t going to plan, try to figure out why. Perhaps your monthly savings amount is too high, or you may not be sticking to your budget closely enough.

It’s fine to adjust your budget and your goals, as your situation changes. And remember, saving a little is still better than saving nothing. The more you have set aside, the less likely it is that you’ll need to borrow if something goes wrong and also the less interest you’ll be charged if you do borrow.

6. Be clear about when you’ll use the money

It can be helpful ahead of time to write down the circumstances when you’ll consider using your emergency fund. Covering a period of unemployment is a good reason, but picking up a new pair of pants probably isn’t. Having clear rules up front can prevent you from being tempted to spend the money on something you’ll regret.

7. Keep it topped up

If you do have to use your emergency fund, you’ll want to set a plan for how you’ll top it back up. You don’t want it to dwindle down over time. You should be able to follow the steps above to get you emergency fund topped up.

8. Make sure you have enough

Your expenses can change over time. It’s worth checking once a year to make sure your emergency fund is still aligned with your expenses. For example, if you have a baby or a buy a pet, you’ll probably find what was 3 months’ worth of expenses a year ago may no longer be enough. So you’ll need to recalculate.

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