Break glass in case of emergency: a guide to building your emergency fund
Having a cash buffer is a big factor in increasing your financial wellbeing
👋 Welcome to the latest issue of How To Money by Kate Campbell – the newsletter that talks about all those money things you wish you had learnt in high school.
✨ If you’re a new reader, thanks for stopping by. You can learn more about How To Money here.
📬 To get future issues delivered to your inbox, enter your email here:
Dear Reader,
Given my book Buying Happiness has been on shelves for at least 1.5 years now (time continues to baffle me), I thought I’d share some excerpts from the book that might be helpful to you on your money journey.
Today, I wanted to talk about emergency funds (Chapter 1), as they are a common goal people set at the start of a new year. Let’s jump in!
You know those weeks when everything goes wrong, and you can’t seem to keep your head above water? You’re looking at your bank account, and you know there’s not enough in there to cover everything, so you pull out that credit card you’ve been keeping for emergencies and resign yourself to going back into debt for the next year or two.
But what if you didn’t have to go into debt?
What if you had money set aside for a situation exactly like this?
This is what your emergency fund is for. It’s money you put aside specifically for the challenges life loves to throw at you, challenges that you can’t really plan for, like a family emergency. It’s also the money that gives you the financial breathing room to leave a toxic job, a bad relationship or an unsafe situation.
This is one of the areas of finance I am most passionate about because while investing is great, having the power to make decisions from a position of financial strength is even better.
So, how much do you need?
There are many different ways to cut this cake, but a good place to start is anywhere from three months to six months of basic living expenses – and having that money stashed in a high-interest savings account (so you can access it when you need to) is important, too.
If you have a good (and financially secure) family support system, work in a highly sought-after role or have multiple sources of income, you might be completely comfortable with a smaller amount in your emergency fund. On the other hand, if nobody can support you if something unexpected happens, you’re financially responsible for other people, or you work in an industry where it could be challenging to secure your next role, you might be more comfortable knowing you’ve got a bigger safety net.
My mum’s had breast cancer twice, and there’s always that thought at the back of my mind that it could come back for a third time. If this ever happens, and I really hope with all my heart that it doesn’t, I want to be able to drop everything to spend quality time with her. That could be flights, unpaid leave from work or a family holiday – and all those things cost money. That’s why having a larger emergency fund is so important to me, even though I could probably get by with much less. I don’t want my choices in a challenging situation to be dictated by my finances.
If you think about it, you’ve probably also faced some challenging situations in which having a break-glass-in-case-of-emergency account would’ve come in handy.
Have I convinced you that you need an emergency fund yet? If so, it’s time to start building one.
Step 1: Open your emergency account
First things first, open a completely separate bank account that isn’t directly linked to a spending account and label it as your dedicated emergency fund. Ideally, this will be a high-interest savings account that won’t charge you account-keeping or withdrawal fees and will allow you to access the money quickly. This account will be used solely for your emergency fund, so you’ll have to practise self-restraint and access it only for emergencies.
Step 2: Set a goal and budget for it
Your next step is to work out how much you’ll need in your emergency fund. Consider your needs and your current financial situation. Once you’ve got a number in mind, you’ll need to make room in your monthly budget for it (unless you’ve already got the money available to move into your emergency fund straight away). Here’s an example:
I’ve determined that I need around $3,000 to feel comfortable, and I’ve worked out that I can reach that goal by transferring $250 into my emergency fund each month for the next 12 months. If I can also take on some extra work during the holidays or sell some items around the house to speed up the process, that would be a bonus!
Remember, whether it’s $500 or six months’ living expenses, you need to work out the appropriate emergency fund goal for you. For example, if you have competing priorities or you’re currently paying off debt, it may be better to start by putting aside just one month of living expenses and committing to building up your emergency fund over time.
Step 3: Set up automatic payments
Once you’ve worked out how much you want to move into your emergency fund each month, set up an automatic payment, depositing the planned amount of money into your emergency fund from the account where you receive your salary. If that’s not an option, put a recurring calendar event in your diary that reminds you to move money across to your emergency fund.
This step draws on US financial educator Ramit Sethi’s automation-centred approach to building wealth and security. This is how he describes the benefits of automating aspects of personal finance:
By setting up a bulletproof personal finance system, you can start to dominate your finances by having your system passively do the right thing for you, leaving you to focus on the things that really matter.
So, put your plan on autopilot and move on to the next step!
Step 4: Be consistent
The key is to be consistent in building your emergency fund. It may take a few years to set up your emergency fund, and you may even need to use it before you reach your goal but don’t be discouraged.
After getting started, continuing to add to your fund until you reach your goal is the most essential part of this process – even if it feels like you’re not really getting anywhere. If you have any unexpected windfalls, such as a tax refund or a bonus, consider them good opportunities to boost your emergency fund.
Step 5: Use – and replenish – your emergency fund
Finally, once you’ve got your emergency fund in place, or at least in progress, don’t be afraid to use that money if something unexpected happens.
That’s what it’s there for!
Think of it as your personal parachute, which you can open in an emergency. If you do have to use your emergency fund, start repairing it immediately!
And that’s great in theory, but it can be a bit harder in practice. If you have difficulty actually spending money after you’ve saved up for something, you may find it challenging to use your emergency fund when you need it.
My suggestion is that you reflect on what situations would warrant breaking the glass, so to speak, and write them down. This ties into your values, so it’ll look different to everyone, but the list could include things like flying interstate for a funeral, taking time off work to support a friend having a tough time, or getting an urgent car repair.
Remember that this money has been put aside by past you to support future you in tough times, and using that support is okay!
It’s true that replenishing an emergency fund that you’ve worked hard to build can feel a little disheartening, but don’t let that stop you. You might need to take a short break and have a breather before you get going again; however, you’ll get there – and this time, you’re not starting from scratch. Not only have you already got your emergency fund account set up and know how much you need, but you’ve also built the skills and discipline required to reach your goal again. So, if this is you, remember you’ve got this!
I’d love to hear if you have an emergency fund or want to build one, so drop me a note in the comments below 👇
All the best for your financial future,
Kate
Thanks for reading
Thanks for reading today’s issue of How To Money. If you enjoyed what you read, I’d really appreciate it if you could share it with a friend, family member, or colleague who you think might like it too.
📚 If you’d like to support my work, the best way is to buy a copy of my book, Buying Happiness: Learn to invest your time and money better through Booktopia, Amazon or order it through your local library.
