What is an emergency fund?
An emergency fund is cash you can access at any time (usually held in a savings account or in a term deposit) and is used to cover unexpected costs that are difficult to predict.
Maybe your car suddenly breaks down, or you have am emergency medical cost to cover. Or maybe your income drops or stops completely.
This is where your emergency fund comes in.
Creating an emergency fund is your first step when planning for your future and protecting yourself on that journey.
Why create an emergency fund?
An emergency fund is the foundation of your future financial security. Creating one is an exercise in committing to your financial resilience, while also establishing a vital tool for staying afloat financially through life's ups and downs.
As you build up your emergency fund, you’ll also begin to see the value of having a habit of saving in general.
It can be a great way to gain the confidence to execute other plans and strategies in the future.
How much do you need in an emergency fund?
The ideal number for an emergency fund will be different for everyone. But a common target is having enough in savings to cover at least three-six months of expenses.
That would give you a buffer to cover most large unexpected one-off costs. And if you lose your income for any reason, it would mean still being able to being meet your obligations for a period of time while you get yourself back on track.
Having a target amount is helpful, but the most important thing is to get started as soon as you can. Even if it's simply committing to saving a small amount regularly. Your emergency fund will gradually build over time.
How to build an emergency fund
Here are some steps to consider as you begin to build your emergency fund:
Step 1
Set up a separate savings account for your emergency fund. Ideally look for an account with a high savings interest rate. If you have a home loan offset account, this can also be a good place to keep your emergency savings.
Step 2
Commit to adding to it consistently (e.g. every time your pay comes in) — you could even automate the transfer so you never forget to do it.
Step 3
Consider making lump sum contributions to speed things up, such as depositing your tax return or your end-of-year work bonus if you get one.
Step 4
Look for ways to make some extra money and commit to using it to build your emergency fund.
Alternatives to an emergency fund and why they aren’t as good
There are a few alternatives to an emergency fund. But a savings account with available cash generally has advantages over most of these, whether it’s in avoiding fees and interest charges, and not getting yourself into debt.
Here are some other options you may come across.
1
BNPL (Buy Now Pay Later)
An overdraft or credit card used to be most people’s introduction to debt, but buy now pay later services have become a popular choice for consumers.
As an emergency solution, BNPL can be an easy and fast solution to set up. But if you haven't planned for how you will pay off the account, you could end up being stung with high fees for missed repayments.
2
Overdraft
You can usually apply for and access an overdraft with just a bank account and debit card, although not all banks offer this. The available amount is determined by your bank based on your financial situation at the time of application.
While an overdraft gives you access to the funds if you need them, you will pay interest on what you borrow, and usually fees whether you use the overdraft or not.
With an emergency fund in a savings account, you will hopefully earn interest on your balance and you generally won't pay any fees.
3
Credit cards
As a backup plan, a credit card can be a convenient option and they often come with perks like reward points.
But the interest charges on credit cards can be very high if you don't repay the balance within the interest free period. This could well be the case with a one-off emergency expense.
A lot of credit cards also come with an annual fee, whether you use the card or not.
You also need to consider the temptation to use the credit card for other kinds of spending and to build up expensive debt in the process.
4
Personal loans
Personal loans are popular for large expenses like buying a car, renovating your home, or financing a wedding.
You borrow a set amount and repay it with interest and any fees over a fixed time period.
But as an emergency solution, even the fastest approval speeds from online lenders may not provide you with the money you need at the moment you need it.
They can also be expensive due to the fees and interest charged, particularly options such as 'pay day' loans which are often marketed towards people who need money urgently but usually come with hefty fees.
You would also need to consider how you would meet the repayments on a personal loan were you or your partner to lose your income.
Important information: Any advice or information on this site is of a general nature only and has not taken into account your personal objectives, financial situation and needs. Because of that, before acting on the advice, you should consider its appropriateness to you, having regard to your personal objectives, financial situation, and needs. Helen Baker is an Authorised Representative(s) of Godfrey Pembroke Group Pty Ltd ABN 38 078 629 973, AFSL number 245451, an Australian Financial Services Licensee, with offices at The Bond, Level 3, 30 Hickson Road, Millers Point NSW 2000.
