Your essential guide to building an emergency fund

An emergency fund is a sum of money you set aside that can support you if you experience a difficult financial time. It might be an unexpected event such as a medical emergency or losing your job, or you might be getting hit hard by the rising cost of living.

The benefit of an emergency fund is that it can act as a monetary buffer while you get back on your feet. Not only does this give you peace of mind but also means that your first resort in an emergency won’t have to be taking out a personal loan or applying for a credit card.

It depends on what your basic cost of living is and what your expectations are for getting through a difficult financial time.

One common metric for building an emergency fund is to set aside at least three months worth of expenses as a safety net, as this can allow you time to recover during potentially upsetting circumstances.

You can figure out what three months worth of expenses looks like for you by creating a budget. When you do this, you’ll be categorising your past spending into fixed, necessary and discretionary expenses, and then subtracting it from your net income.

Use Mozo’s free budget calculator to get started.

Types of expenses you’ll need to consider when creating your budget include:

• Housing (home loan repayments or rent costs)
• Utility costs (electricity, gas, water, internet and phone bills)
• Basic food and household items
• Daily travel (via public transport or a personal vehicle)
• Car, home and life insurance if applicable
• Loan and credit card repayments if applicable
• Occasional expenses such as car repairs, medical appointments and dental checks
• One-off purchases such as clothing or a meal out
• Extra expenses that may pile on top of emergency costs (perhaps you’ve lost your job but also need to buy a laptop, as you used the work device for personal admin).

Example of a three month emergency fund

If you calculate your monthly expenses to be $4,000, then your three month emergency fund goal is $12,000. If your expenses are $5,000 a month, then you should aim for $15,000 in your emergency fund, and so on.

The time it takes for you to save up for an emergency fund depends on what your income and expenses are. One way to figure out the timeframe is to choose a rough savings amount and how often you’ll be able to deposit this amount into your emergency fund. 

Once you know this, you can use the Mozo savings calculator to see how long it will take you to reach your goal.

It’s best to have a separate savings account for your emergency fund – that way, you’ll be deterred from dipping into it for your everyday expenses.

Before starting your emergency fund, it’s a good idea to compare savings accounts and choose one with a high interest rate to deposit your money into. That way, you can maximise your cash with relatively little effort.

It’s important to note that some banks will decrease your interest rate if you withdraw from your savings account, so make sure you only do so when absolutely necessary.

In addition to this, most high interest savings accounts only offer you the maximum rate when you meet a certain set of conditions.

If you have a mortgage, you might consider an offset account as a home for your emergency fund. By depositing money in an account attached to your home loan, you can reduce the interest paid on your mortgage as the loan principal is balanced out by this additional sum.

Using an offset account is a simple way to reduce the interest accruing on your home loan while storing your savings.

You may be saving for multiple goals right now – maybe you’re saving for a deposit on a home loan, or stashing cash to go on a holiday. But circumstances can always change, so it’s important to be prepared.

For example, your emergency fund might save you in the event of:

• An unhealthy work environment: An emergency fund means you can leave a difficult work environment and take time to find a new position without putting yourself in financial or mental distress.
• A break up: You could still be in a shared living arrangement and need to find a way out. With an emergency fund, you can rely on your saved cash to help you navigate moving costs.
• A sudden financial upset: Unemployment, unexpected medical bills or family finance issues can all happen out of the blue. Access to emergency funds can save you from committing to a line of credit which will accrue interest and cost more in the long run.

You should only use your emergency fund when it is a genuine emergency. To assess whether or not something classifies as such, you should first identify if the situation is:

• Unexpected: An emergency isn’t a looming debt you’ve been ignoring for months. Save on stress and extra fees by paying off loans and other costs in a timely manner instead of scrambling for finances in the final hour.
• Urgent: Does it need to be sorted out within your next pay cycle? If not, and if you’ve got the cash at hand to cover it, it’s most likely not an emergency.
• Necessary: If your income can sufficiently sort things, don’t dip into the emergency fund.

There are many circumstances that might fall under all of these categories, from the washing machine breaking to your house suffering fire or water damage and becoming unlivable.

The problem may only require a few hundred dollars, or it could eat up the best part of your emergency stash – all the more reason to be financially prepared for any eventuality.

• Have a budget: Knowing and maintaining your living costs will help you set a savings schedule and the amount you can feasibly put away each pay cycle, whether it’s weekly or monthly. If you don’t think you can find extra dosh in your current budget, it may be time to find ways to cut costs.
• Have a set savings goal: Decide on how much money you want to have in your emergency fund, and then divide that by your budgeted savings amount each month and you’ll have organised a timeframe in which to get there.
• Adjust savings when applicable: Some weeks will be fairer than others, considering bill payment dates and the occasional social splurge. So, allow for some flexibility in your savings while maintaining healthy financial habits by sticking to payment frequency but increasing or decreasing deposit amounts when appropriate.
• Set up automatic transfers: If you haven’t been a scrupulous saver in the past, set up an automatic bank transfer whenever your income is deposited so part of it moves into your emergency savings account.

Also consider any costs you may be able to cut back on to redirect your money into your savings. These may include:

• Utility providers: We encourage you to shop around and search for the best deal on the market for all your utility costs. For example, you might want to check how much you’re paying for your internet bill, and then compare NBN plans to see if you can find a cheaper option.
• Home loan options: If you’ve been chipping away at your mortgage for some time, you might not have investigated how competitive your rates are. Look into refinancing your home loan to potentially make some big bucks that’ll help out in tough times.
• Insurance costs: You want to be as efficient as possible with set costs such as insurance, so make sure you’ve assessed any policies you have to suit your current needs and reduce unnecessary costs whenever possible.
• Other accounts: Are you paying fees or getting a poor interest rate return on your savings accounts or term deposits? If you’ve got a few accounts bubbling away, this could add up to a considerable amount, so keep it in check.
• Subscriptions: It might be a streaming subscription you no longer need or a long-forgotten exercise app, but whatever subscriptions you’re not using should be cancelled.
• Discretionary spending: There may be a few luxuries you’re currently indulging in you could live without as you aim for that emergency savings goal.