Part 3: EMERGENCY FUND - Financial Independence Series
25 Feb, 2024
The best thing I ever did was set some cash into a bank account, which we could instantly access in a financial emergency.
It is an amount of money set aside in a specific bank account to be used for bailing myself out if something happens that I didn’t otherwise plan for but I need money to pay for.
It takes me less than one minute to log into my banking and move money from my emergency account to my spending account.
I can’t plan for everything.
My previous blog post discussed budgeting and planning for upcoming expenses. However, try as I might, I can’t think of everything. Your emergency fund covers the things you forgot despite your best intentions.
What have I used my emergency fund for in the last 12 months?
Accommodation and various expenses in Dunedin when Mum ended up in hospital with Covid.
I had an unexpectedly high car repair bill in addition to what I had budgeted for.
What have we used it for in the past?
Unplanned dental treatment.
I had to top up our everyday bank account when, despite our best efforts, we didn’t earn enough monthly income to cover all our expenses.
Let’s not forget the biggest jolt our lives ever had: Coping with the short-term financial crisis of the Canterbury Earthquakes that began in 2011 and went on for years. If there was one thing that cemented the need for an emergency fund, it was this event. Because of our large emergency fund, of all the troubles we faced, money was the least of our concerns, and to this day, I feel a sense of relief when I think back on that time.
The feedback I receive agrees with me.
I’m lucky many people email me telling me how unlucky they have been with money. I’m fortunate because I have sat on the sidelines watching a situation go from crisis to confidence, and most will credit setting up an emergency fund as a HUGE factor in getting on track with money. Whether they manage very little or millions of dollars, people who budget and plan for an emergency feel a sense of calmness about their pūtea.
Having money sitting in an account, ready to access immediately, will stop you from reaching for a credit card, dipping into your mortgage or reaching for some kind of buy now pay later scheme to pay a bill. If you do that, that’s all just more debt you are adding to your life, and in an emergency, that’s the LAST thing you want to turn to, as it has the potential to make a bad situation worse.
If the concept of an emergency fund is new to you, here is how you make a start.
Set up a bank account and give it a name that tells you that the money in this special place is for emergencies ONLY. I’ve heard some great names over the years:
“Emergency Fund”
“Holy S**t Fund”
“I’ll Save Myself Fund”
“I’ve Got This Fund”
“Feck You Fund”
Start Small - Or Go Large
If money is tight for you, automatically transfer a small set amount into this new account. Schedule it for the day you are paid. You aim to build this account quickly, so put a bit of pressure on yourself to make these transfers meaningful. Your goal is to reach $1,000 as fast as you can. Then you aim for $2,000. Then $3,000.
Alternatively, if you have the financial means, completely fill up this account now.
For every $100 you manage to put into this account, you have bought yourself the solution to a problem that may arise. If your car fails a warrant of fitness because you need a new tyre, $100 should go a long way to paying for it.
The higher the balance of your emergency fund, the less stress you will feel when expected costs come up, and the faster you can solve your problems.
How much money should you have in your emergency fund?
If you are busy paying off consumer debt, aiming for $1,000 - $2,000 will be helpful. It will stop you from reaching for more consumer debt if a $500 problem occurs. You won’t have to put your crisis on a credit card, store card or BNPL scheme anymore.
Once you are consumer debt-free and budgeting well, aiming to have three to six months of expenses in your emergency fund is a good idea. Once you reach your number, cap it at that; there is no need to add any more. When some people get the wind in their sails, they can become a bit overzealous with how much they have in their emergency fund, when in reality, 3-6 months is a good amount to have—or 12 months of expenses tops. Money, in addition to this, could be better used elsewhere in your life, such as making higher payments on your mortgage or investing to grow wealth. Or you could spend it, of course!
A mountain becomes a gentle slope.
If you are starting from $0 in your emergency fund, hearing me encourage you to ‘simply’ save up $1,000 and potentially tens of thousands of dollars could make you feel defeated before you begin. Believe me, I know it's hard.
I want you to get motivated, not put off, so snap out of this thinking, put your reservations to one side, and just start anyway.
Put your goal in context.
An emergency fund is just another sinking fund, and if you have read my previous posts, you have already set up a few. As with any sinking fund, with regular deposits made over a long period, it's slow initially, but it gets easier.
If you were to deposit $50 a week into your emergency fund:
Week 1: $50, Week 2: $100, Week 3: $150, Week 4: $200
Would you worry less knowing that after just four short weeks, you could have $200 set aside? Yes, you know you would.
Week 8: $400, Week 12: $600
Would you worry less about your money if you knew that in 12 weeks, just three months from now, you could have $600 to fight any financial fires? Yes, you know you would.
Week 20: $1,000. You have arrived at your goal! It took you five short months!
So, while the goal of $1,000 might seem big, breaking it down into small steps makes it attainable.
Once you reach your goal, whatever the amount may be, you cap it there, and you can stop your auto payments and just let it sit there, poised and ready to help you when required.
I’ve noticed that once people decide to set up an emergency fund, they will create these small weekly transfers but then get impatient to fill it up and hit their number. They work extra shifts, sell stuff they don’t use, cut unnecessary spending, and speed up the process. You won’t hear any arguments from me. Get after it!
Your emergency fund balance will change over time.
The last time I wrote about my emergency fund, the balance was $14,000. We could live on this amount for four months or six months at a stretch if required. At the time, Jonny was self-employed, and I worked a permanent part-time PAYE job. Plus, we had a side income from this blog. Our outgoings were stable, but I saw three main risks to our income:
His work could dry up
I could get laid off
My blog could disappear at the whim of the internet
However, we have recently reduced our Emergency Fund balance to $9,000. Why?
Jonny and I are both working permanent part-time PAYE jobs that are stable
Income from the blog appears to be steady
Our sinking fund balances are stable
Our spending is stable
The value of our ETF investments has increased
Therefore, I am confident that most of our problems could be solved with $9,000. History has shown me that we are more likely to need to access smaller amounts more often. If our financial problem was more than $9,000, we could, if required, immediately sell off a portion of our investments. I don’t want to do that, but I could if needed.
I’m also confident that I’ve got a good backup plan.
You can assess your position from time to time and make the call on the size of your emergency fund.
Emergency Fund FAQs.
Should an emergency fund be working for you?
I will sometimes be told, “Ruth, an emergency fund should be working for you”. They think its purpose is to make more money.
That is NOT the purpose of an emergency fund. It's to help you rest well at night and not worry about money. Yes, it might make a little bit of interest because you put it in a “high-interest” yet immediately accessible bank account, but that’s just a happy coincidence.
I’ve been told you can offset it against a mortgage, thus reducing the interest you pay on your debt. Or invest it in some way to receive dividends or capital gains. Perhaps tie it up in a term deposit, or, in my view, the worst idea, pay for the emergency with a credit card (debt) that you can then earn points on and pay off using your emergency fund at the due date.
Offsetting it against your mortgage may be something to consider, but only if the money were still in a clearly marked ‘emergency fund’ account. But I’d say NO to the rest. You need immediate access to your emergency fund to solve your problem and not have to carry out mental gymnastics while doing it.
For example, my problem last October was that my Mum was rushed to hospital with Covid. Chance of dying from it: High. I immediately used money from our emergency fund to book a hotel room and then jumped in the car and went to be with Mum. My problem was permanently sorted/ended/solved within two minutes with zero stress. Leaving me plenty of time to stress about more important things, my Mum. One night led to four, plus multiple other expenses, but I paid in full each time with no issue. Thankfully, she recovered.
Financial problems often get drawn out, but with a big emergency fund behind me, I could keep fighting the fires as they popped up. My Mum was my focus, not my money.
The issue with tying your emergency fund up in a term deposit or investment or putting it on a credit card is that you put too many barriers in the way of solving your problem. So, just don’t, OK?
My emergency fund is working its guts out for me because I feel calm every time I look at it in my bank account. I don’t know ‘what’ might go wrong, but I understand that something will happen and that if money will help fix it, I’m all sorted.
Should you invest your emergency fund?
Just to zero in on the “you should invest this money instead” argument. One huge factor I think is often overlooked is that if you manage your money well, as I try to do, the $9,000 ‘tied up’ in my emergency fund represents just 1.8% of our total investments. If I include our home, it's just .6%. The fact that this tiny percentage only earns the bank interest rate will not move the needle on our entire net worth. But the peace of mind it gives me is priceless.
Can you keep your sticky mitts off it?
Can you keep your sticky mitts off your emergency fund money? If you build yours up to $10,000, and it's sitting in an accessible bank account looking all shiny, bright and inviting, do you have the willpower not to spend it on other random stuff?
Personally, I have no trouble keeping my sticky mitts off our emergency fund, but if you put a bowl of green onion chips and the classic Kiwi onion dip on a table beside me now, would I have the resolve not to eat it? I’m not going to lie; I would struggle. I understand temptation.
Telling ourselves NO should be enough. For me, it is. But if you need more friction between you and your emergency fund, an easy fix is putting your emergency fund in a high-interest savings account with a different bank. Keep the login details secure, but don’t memorise them. You must make some effort to locate these details and move money between your emergency fund and spending accounts to access this money. You won’t solve your money problem as fast as I do, but having that small degree of separation and time lag is hopefully enough to keep it out of sight and, therefore, out of mind.
Other than that, I’ve got no great insights to share here. It's up to you to wrestle with your conscience on this one. But how disappointed would you be with yourself if a genuine financial emergency did come up, such as the death of your partner, and you didn’t have the money to pay for a funeral because you blew it on consumer goods instead?
Some emergencies are profoundly traumatising, and all I want for you is the knowledge that at what might be the lowest point of your life, having the money to cope with it is there, ready and waiting, leaving you to cope with all the other things going on.
Your credit card is a terrible emergency fund.
Your credit card is not your emergency fund. If you have access to a line of credit, also known as debt, and that’s your big plan, to use that when the dog needs the vet ($5,000) or the car blows up ($10,000), then I’m telling you, it's a bad plan.
If you use it, now you have a large payment due in a month, and if you don’t get it paid off in full, your emergency will now cost you the initial expense plus 25% interest. Bad plan. People who do this end up raiding every sinking fund they may have set up for other purposes, postponing things they had planned and just generally chasing their tail to address the crisis they created by not having an emergency fund.
Did you use your emergency fund for an emergency?
Well done if you have an emergency fund and have to dip into it to cover an unexpected expense. You have immediately solved your problem. How did it feel to feel so in control of the situation?
Now, priority #1 is topping the account back up again. To do this, I set up a weekly auto payment of a set amount into this account until it's filled back up to the correct amount again. I’ll hustle if I need to fill it up faster. As soon as that is done (and it might take weeks or months, depending on how much you have drained), stop that payment and move on with your day.
But make sure you reflect on how awesome it felt not to need to use borrowed money to solve a problem.
The final word on emergency funds.
Whether you manage a little money or a lot, please ensure a small portion is placed on one side for use in an emergency. I can’t recall when I first had the ah-ha moment to set one up, but I strongly suspect that it coincided with me feeling less stress and anxiety about money.
It's the type of life admin that needs consistent attention in the beginning, but once it's built up and you have had to use it a few times, it's something that you know you just can’t be without.
We have now covered net worth, budgeting and emergency funds, and next time, I’ll be addressing KiwiSaver.
