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Do I need an emergency fund?

Unexpected events can come out of nowhere and blindside a budget. Covering these sorts of situations is why you need an emergency fund. This begs the question: how much money do you need in your emergency fund and what’s the best way to save for it?

It’s Friday afternoon and your manager calls a team meeting. It’s a colleague’s birthday and you’re expecting to see a cake. Instead, there’s a manager you’ve never met before who delivers the news that the business is restructuring. You and your team are being let go.

You walk out of the meeting feeling numb. Only on the drive home does reality start to sink in. You have your mortgage to pay, school fees, car payments, insurance, a holiday coming up. Your food bill alone is more than $1000 a month.

“But that won’t happen to me”.

Prior to the pandemic, most people would have thought their job was secure. Then the entire world was thrown a financial curveball and suddenly millions of Australians were facing business closures and catastrophic job losses.

Some people fell softly onto the safety of their rainy day savings, while others landed on the not-so-soft government welfare net. Fortunately, the government safety net got stronger, but not everyone was eligible. And for those who did qualify, support payments did not always fully cover their household expenses.

Many Australians don’t have any emergency savings goals

According to a 2021 report from ME Bank, 18% of Australians had less than $1000 in cash savings in their rainy day account, with 44% of that sample size having $100 or less. Meanwhile, according to a a separate study conducted by Deloitte and Compare the Market revealed that 13.4 million (or 68% of Australians) don’t have a sufficient rainy day account to cover an income interruption of three months.

We live in one of the richest countries in the world, so how did this happen?

“A lot of people think of their personal finances in terms of cash-flow,” explains MyBudget founder and finance expert Tammy Barton. “They look at their bank statement or credit card bill at the end of month to see if more money came in than went out. But to protect yourself from what-ifs and to really get ahead, you can’t plan by looking in the rear-view mirror. You need the right tools to help you plan forward.”

How much money do I need in my emergency fund?

Tammy advises that there are no rules as to how big your safety net needs to be, but there are some rough guidelines for your emergency savings goal.

If you have existing debts – especially a high interest personal loan or credit card debt – paying off that debt should take priority over saving. But this doesn’t mean you should have no emergency savings at all.

“Even if you have credit card debt, I would recommend saving up $1000 cash in the bank. This will give you savings to fall back on and won’t have to rely on your credit card in an emergency,” says Tammy.

Tammy continues, “Meanwhile, throw all your spare cash at your high interest debts to pay them off as fast as you can. Once they’re eliminated, then you can grow your emergency fund even more.”

For everyone else, your emergency savings goal is going to come down to your individual financial commitments. For example, a family of four with a mortgage, school fees and bills will have to cover higher monthly expenses than a twenty-something living at home.

Work out your needs from your wants

The first step towards your emergency savings goal is to look at all of your expenses and separate them into needs and wants. Print off your last couple of months of credit card and bank statements and go through them with two highlighter pens. For instance, use yellow to highlight your basic, essential living expenses; pink for everything else.

Your essential expenses represent what it costs to keep a roof over your head, food on the table, a car on the road (or other form of transport) and other essentials, like medicines. For some households, their basic costs might also include education.

Everything else is discretionary or optional spending. Think: Netflix, gym membership, eating out, going to the pub, and so on. In tough times and when need be, your discretionary expenses can be cut. If you were to lose your job, for example, you could suspend your Foxtel subscription for a couple of months and draw from your rainy day account, but you’d have to keep paying your rent.

A person lays coins out on a table and slowly counts each one as they put their coins in a jar.

How to calculate the size of your emergency savings goal

When working out how much you need in your emergency fund, a good goal is to have enough savings to cover three months’ worth of essential expenses. Six months would be even better, according to Tammy.

The most recent Australian Bureau of Statistics Australian household expenditure report (2015-2016 survey data) indicated that the average household spends $846 a week on basic costs (2015-2016 survey data). Multiply $850 by 12 weeks and you have a savings safety net goal of $10,200. We also know that cost of living pressures in 2022 has exacerbated living situations, with the ABS revealing that average household spending has increased by 10.2% throughout the first half of 2022.

But don’t despair if that figure seems like a stretch. “The idea is to save up that amount over time,” encourages Tammy. “Just $10 a week would mean you’d have a contingency savings of more than $500 within a year. When it comes to your emergency fund, any amount you have saved is better than zero.”.

Finding more money for your rainy day account

If you’re finding it hard to save, Tammy recommends making a budget to analyse your spending habits. “First of all, print off your last couple of months of credit card and bank statements and go through them with two highlighter pens,” recommends Tammy. “One colour equals ‘essential’ and the other equals ‘non-essential.’

For example, use yellow to highlight your essential living expenses, like rent, food and petrol, and use pink for everything else.”

Your essential expenses represent what it costs to keep a roof over your head, food on the table, a car on the road (or other form of transport) and other essentials, such as medicines. Everything else is discretionary or non-essential spending. Think: Netflix, Spotify, gym membership, eating out, fashion, gadgets, sweets and snacks, going to the pub, and so on.

To boost your rainy day account, non-essential expenses can be reduced or cut for a period of time while you build up your savings.

A person uses a calculator with coins stacked in incrementally bigger towers, with a piggybank sitting next to the coins.

Create a saving system

The secret to building up your safety net may be simpler than you think. It’s all about having a plan and supporting that plan with a system. The more set-and-forget that system is, the better.

“For most people, extra money is hiding in their spending habits,” says Tammy. “You might be able to save $5 to $20 a day just by making your morning coffee at home and bringing your lunch to work. Some people save thousands a year by shopping around for cheaper insurance or by switching to a cheaper phone plan.”

To give your emergency fund an instant boost, you could add in any lump sums you receive, such as your tax refund, a work bonus or birthday money. You could clean out your cupboards and sell some items you no longer need in an old fashioned garage sale.

How to create your emergency fund

Once you’ve worked out your savings goal and how much you can afford to put aside, it’s time to take action. Remember, even just $5 a week is a great starting point. Small savings will add up over time.

As Tammy recommends, your emergency savings or rainy day account should be kept in a separate savings account. Not a jar or envelope or under the mattress. Unless you’re very disciplined, those hiding places are too easy to access.

The one exception are mortgage holders who have an interest offset account or redraw facility attached to their home loan. If so, keep your emergency savings in that account to reduce your mortgage interest.

To save regularly, explains Tammy, it’s best to set up a direct debit or automatic transfer into your rainy day account every time you get paid. And to avoid temptation, opt out of having a debit card attached to that account.

At MyBudget, our clients’ income is automatically organised into their budgeted expenses and savings streams. This sort of money automation is powerful because it requires no effort and sets you quickly on the path towards your goals.

“Once you’ve saved up $1000, you might consider putting the money into a term deposit, “ says Tammy. “Just be aware that interest rates are incredibly low right now and locking your savings into a term deposit might mean break fees if you need to access your money before the term ends.”

A person places one coin into a small piggybank.

Hopefully, after reading this article you’ve gone from asking “Do I need an emergency fund?” to working on your emergency savings goal.

Whatever your money needs, there is a MyBudget solution to help you reach them. Get a free customised budget that prepares your finances for every ‘what if’. Otherwise if you’re looking for more specific answers around how much you need for an emergency fund, call 1300 300 922 for a quick chat with one of our friendly team members.

You can also book your free budget consultation using that number or enquire online.

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This article has been prepared for information purposes only, and does not constitute personal financial advice. The information has been prepared without taking into account your personal objectives, financial situation or needs. Before acting on any information in this article you should consider the appropriateness of the information having regard to your objectives, financial situation and needs.