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Should you have an emergency fund?

3 min read

Most people would agree that it’s a good idea to have some kind of plan to support yourself financially should the income suddenly dry up. That’s where emergency funds come in. But are they really necessary? Should you focus on debt first? And how much of a buffer should you aim for?

Why would I need an emergency fund?

Unless you’re quite wealthy, for many of us there’s a good chance your pay packet is virtually chewed up each month just through the cost of living. This doesn’t leave much wiggle room should you run into unexpected financial difficulty. It could be just about anything, perhaps you lost your job and suddenly have no income, or maybe you’re stuck with a large bill for house or car repair, or even medical expenses like emergency dental work. Whatever it is, being stuck with a large, unexpected expense that you can’t cover is stressful to say the least. This is why having an emergency fund is a good idea.

What is an emergency fund?

Having an emergency fund is really just another way of saying you have some money saved up that you can tap into to cover unexpected expenses. Some people consider their credit card as being their backstop, and it can certainly help cover fairly large one off expenses, however, if it’s your income that dries up, creating more debt will quickly make things worse.

How much do I need?

There are no hard and fast rules around how much you should have and mostly it’s going to depend on your situation. For example, do you have a family to support or are you on your own? How much debt are you servicing? How many costs can you cut back on? The answers to these questions will dictate exactly how large your emergency fund needs to be.

With that in mind, imagine a worst-case scenario, such as losing your job. How long might it take to find work again? Three months or longer isn’t out of the question. So start with that figure and work backwards from there to calculate how much money you’d need to cover living expenses and bills for that period of time.

How much is too much?

While it’s relatively easy to determine a minimum figure for an emergency fund, working out the sweet spot in terms of the maximum is a whole other question. Again, there are many variables and the answer will be different for everyone, but simply building a giant emergency fund isn’t the smartest way of approaching it, after all, just because you’re building an emergency find, doesn’t mean you can’t make those savings work for you.

Think about splitting your emergency fund into two parts. That way you might have a portion of it in an interest bearing savings account that offers easy access should disaster strike. But then think about putting the rest into a longer term investment such as a term deposit. This might mean that portion of your emergency fund is locked away temporarily, but it’ll be growing at a faster rate than it would otherwise. The long term pay off here is that, if you’re lucky enough never to need the emergency fund, it’ll be growing while it waits. You can, however, break a term deposit if you find yourself in financial hardship.

Other options

Even though an emergency fund is a good thing to have, make sure you balance your approach with your current financial situation. For example, if you have a lot of high interest debt, then pouring all your spare money into savings isn’t the smartest thing to do as you’ll end up paying more in interest. Ensure you strike a balance between paying down that debt and putting money aside.

Likewise, many of us have insurance that will cover a sudden loss of income or unexpected repairs. In fact, some employers might even offer redundancy insurance to their staff, so it’s worth checking if your employer does this. You may already have more protection than you realise, so dig out those policy documents or give your insurer a call to see what the story is.

Lastly, if you own a home and have a decent amount of equity, you might be able to tap into that equity as a line of credit. Talk to your bank about this option, but always bear in mind this will incur extra interest costs that can mount up over time.

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