If you’re asking yourself, do I need an emergency fund?
The answer is always yes.
If you’re asking yourself, how much do I need to save in my emergency fund? Keep reading.
So what is an emergency fund?
An emergency fund is money, set aside, to cover an unexpected expense or emergency. The things that qualify as emergencies change as you get older and the amount you have saved generally increases.
It feels like this really complicated and difficult concept of ‘money set aside for the unexpected’ especially because when we’re young, everything that seems bad seems really far away. We’re infallible.
But here’s the problem.
If something bad does happen and you don’t have a family with which to fall back on for financial support or some cash at hand, then the next best thing is a credit card. Or a pay day loan depending on how dire your circumstances are.
These aren’t intended to cover money you don’t have. That’s not the point of a credit card.
An emergency fund however is supposed to be that safety net.
It’s the money that stops losing your job from moving you into credit card debt and bankruptcy.
It’s the money that means you can book expensive last minute flights to go and see a relative when they’re sick.
It's the money that makes messing up which money your pay goes into a minor inconvenience rather than a dire situation. It's literally a soft place to land when your finances are in a rough place.
How much do I need to save in an emergency fund?
This is super personal but I’m going to try help give you some guidance.
When I was 18, I should have had around $1000.
- $1000 was about 2 months of expenses and spending if I lost my job
- It would’ve covered the excess on my insurance which was my single highest expense at the time
At that age, between living at home and working in retail, I would’ve been able to find a job in that time.
Now, there’s plenty of different ways you can calculate your emergency fund goal but a lot of people recommend ‘a few months expenses’
How much should I save in an emergency fund?
This is so personal and so dependent on your circumstances. A good answer is well, how much is your job worth? There’s so many ‘guru’s who recommend different figures. Dave Ramsey says $1000 but that’s not even a month of rent if you’re in Sydney. Other people use a more flexible [X] months’ expenses. If you’re young, I think this can be lower. If you’re older, maybe 3. Maybe 6. Maybe 12 if that helps you sleep at night. In essence, it should be based on YOUR life and YOUR budget and circumstances.
But lets assume it is 3 months expenses.
What should you factor into your emergency fund?
It needs to cover all your expenses for that period. Now, you can decide whether it is ‘rice and beans for 3 months’ or whether it is ‘normal life for 3 months’. How long it’ll take you to save to fill it up will depend on either decision.
I take a ‘normal life for 3 months’ approach and base it on my normal expenses (this means my investment property mortgage, insurance payments, car maintenance and expenses like petrol or tolls etc). Basically, it is my normal budget for 3 months without any additional investments for that period.
Some other factors to consider:
- Do you have kids?
- Do you work in an industry where it takes a long time to get hired? For example I’m a lawyer, and we can expect a 3 month lead time
- Are you a contractor or work in a volatile industry where you might lose your job?
- Do you only have one source of income?
- Are you the sole breadwinner in your family?
- Are you living at home or renting or have a mortgage?
- Do you have any debts that’ll need to be paid in that period?
What else do I need to know?
But mostly – never let yourself be stuck in a shitty situation because of money. An emergency fund is your get of jail free card from a horrible tenancy situation, a toxic relationship, a car requiring urgent repairs or getting stuck in a weird Airbnb situation while on holidays.
My best tip? Once you’ve hit your goal, keep contributing to it because life only gets more expensive as you get older. If $1K was enough at 18, it may not be enough at 25.
Equally, the emergency fund you built when you were 25 may no longer be serving you with a mortgage at 35.
I set a $25 recurring transaction once I hit my original $5K goal each pay so that it would keep increasing. Now, this is completely up to you but it was savings’ I didn’t think too much about. Once I felt the emergency fund was a little bloated, I’d invest the money or save it or splurge or do wHATEVER I wanted because I had the peace of mind that I had a soft landing place if things went completely upside down.
All the best my financial friends,