Author: Mr DDU.
What is an emergency fund?
(You probably know what this is, but I’m going to break it down simply for you anyway.)
An emergency fund is money held separately that can be utilised in an emergency, such as your car breaking down or losing your job. In these situations you need a reliable safety net of money available immediately.
Why is an emergency fund important to us?
Our Emergency fund is extremely important to us; it gives us the security and peace of mind that we can deal with any problem that comes along. We can’t plan when an emergency is going to happen in our lives, if we could see the future we’d have won the lottery or bought Apple shares years ago (we wish).
Facing the potential realistic cost of major car repairs, or losing our main stream of income, means our emergency fund needs to be able to comfortably cover those costs, as they will probably be more than $250.
If you are reading this quite a bit later than when it was posted, information in this article might not be current.
How do we choose how much to have?
We didn’t strictly have an emergency fund to begin with, though we did have some savings which was all in one account and eventually set up an account specifically for our emergency fund. We started by transferring $200 a month into this account until we had 1 month of expenses and gradually built from there (here’s an example of our monthly expenses). Expenses are a better gauge to go off than income; if we need to survive 3 months with no wage, we have to plan for our how much money we would spend not how much we were earning.
A good rule of thumb that we follow is that for every dependent you have, you should have at least that many in monthly expenses saved. Eg if you have a spouse and 3 kids, you should have at least 4 months of expenses worth of an emergency fund.
One of the hardest parts of having an emergency fund is training ourselves not to spend it, to see the money as untouchable unless it is a true emergency situation. It takes time to build the fund up again, so we have to make sure we are using the true definition of an emergency, rather than just unexpected expenses.
What about credit cards, loans or stocks as an emergency fund?
Some people think that they don’t need an emergency fund because they can use their credit card, get a loan or sell some of their assets. They are certainly entitled to have that approach if they want to, but for us there are several reasons why we don’t take that approach:
- We don’t want to get into any debt (except a mortgage) in any circumstance.
- When we are in a vulnerable state the last thing we need is to be going to a bank or loan shark – they may reject us (then we’re really screwed), but they will certainly charge us an excessive interest rate, making it even harder to pay off and get back to square one after the emergency.
- Having an emergency fund means we earn interest instead of paying interest on a loan or credit card. We get to feel safe and secure having money for emergencies and get paid interest in the process, who doesn’t love free money?
- Selling stocks is interesting idea, as your money is supposedly working harder whilst waiting for an emergency. But it means that when you do sell, it will still take a few days to get the money (what if you need it immediately that day?) and you might be selling stocks at a bad time, such as if the market has dipped. What if you’d lost your job in the 2008 crisis? You might have allocated 4 months of expenses in stocks, but if your stocks half like in 2008, you’ve only got 2 months, the price of stocks isn’t concrete.
The future of our emergency fund
Even though there’s only one dependent in our lives (one spouse, each other), we have 3 months of expenses set aside as an emergency fund in an online bank account earning 1.8% interest (we have 2 other bank accounts earning more interest than this). We can withdraw money from this account instantly without losing the interest earned that month.
In the medium term we would like to have up to 6 months of expenses set aside. As our family & income grow over the course of our lives, our emergency fund will gradually grow with us.
Do you have an emergency fund? How do you decide how much to set aside?
Thanks for reading this article about our investing journey Down Under.
Onwards and upwards!