An emergency fund (EF) is a stash of cash you keep tucked away for any unplanned expenses that may come up. Having this type of savings will avoid you going into debt to cover the cost of the emergency. Taking out debt will see you paying interest for the privilege of someone lending you money. This "privilege" is a cost you can avoid by simply saving some cash for those "just in case" moments in life.
Types of unplanned expenses could be a job loss, an appliance that breaks and needs replacing, unexpected car repairs, etc. Those shoes that you "must" have or that weekend away that you "deserve" DO NOT count as an emergency expense. Just saying.
How much money you save for an emergency fund should be enough so that you feel comfortable that you could cover just about any unplanned expense that you can think of. A good rule of thumb is at least 3 to 6 months worth of every day expenses, but that could be more or less depending on your situation. To calculate that number, you would tally up what you spend in a month and multiply that by 3 or 6.
It's always a good idea to keep this sum of money somewhere where it's easily accessible, such as a high yield savings account (HYSA) or a mortgage offset account. The HYSA will gain a little bit of interest each month and the mortgage offset account will save you interest on your loan while the money is sitting in there, which is a bit of a bonus.
Where you don't want it is anywhere where it could take more than a few days to get your money, or somewhere where your money could lose value in the short term, such as the stock market.
Here are a 5 few reasons why you need an emergency fund & how it can save your bacon if something unexpected comes up:
1. You lose your job or hours are reduced
Everyone would like to think that their job is super secure and there's no chance of getting the sack. While some industries and professions are more stable than others, there's always a risk that something terrible could happen. If anything, 2020 has taught us that this is entirely possible.
Losing your main source of income will put a major stress on your finances. Would you have enough to cover your cost of living for a day, a week, a month, or longer? 59% of Americans, 53% of Canadians and 46% of Australians are reported to be living paycheck to paycheck. That's basically half of the population that couldn't afford to live longer than a few weeks without any income!
By having a savings buffer you can take your time to find your next job. If you lost your job today and had to find another one by the end of the week you'll likely have to take the first option that comes by.
This could mean you end up working in an area or location that doesn't suit you or your family, which can add more stress to the situation. Taking the time to research and select your next opportunity on YOUR terms is a much better scenario and will definitely lead to a better outcome.
2. A medical emergency
I always recommend having health insurance that is a good fit for you and your circumstances. Depending on where you live in the world this can be fairly cost effective and cover most things, or it can be pretty expensive every month (like in the US for example).
You will likely pay a premium each month and in some cases pay a fee if health care services are provided. This fee is called a deductible. Setting a higher deductible will lower your monthly premium, but it means you have to cough up a larger amount should something occur. This may not always be the case and will depend on which plan you have and the coverage you've selected so always read the T's & C's of your plan.
Health insurance will only cover so much though, and it's limited to who you have nominated on your plan, which is most likely you, your spouse and your children.
What's not usually covered is if your mother, father, sibling, aunt, uncle or anyone else has an illness or accident. You'll likely want to travel to be with them and give your support. Depending on how far away they live, this could cost a pretty penny and something that you'll have to pay for out of pocket.
We know all too well how much it costs to fly a family of four from Canada to Australia on a days notice due to a death in the family. This happened to us in June 2019 and we didn't have an emergency fund to cover the expense, so we had to borrow money from a family member. Not a good situation to be in.
3. A home appliance dies or you have emergency home repairs
The hot water system has finally had enough. Your washing machine decides it no longer wants to spin. The roof decides water needs to be in the house rather than out. These things happen in life, and often more than once.
While some things around the home can be repaired, some are cheaper just to replace all together. As an electrician by trade, I know the call out rates that people charge for repairs in the industry and they're not cheap!
A hot water system could cost you over $1000 to replace, and if it's due to a leak you could be mopping up the cost of repairing any water damage it may have caused to the house.
It's a similar story for most other appliances around the house. They'll usually cost you a few hundred to a few thousand to repair or replace so it's always a good idea to keep an emergency fund for if (or when) these situations arise.
4. Your pet has a major accident
No one wishes ill for poor Fido, but sometimes pets get into mischief with another animal or have an encounter with a moving vehicle and need some TLC. If anyone has had an emergency visit to the vet before, you'll know that this can cost a small fortune.
Sure, you could sign up for pet insurance so something like this could be covered, but you'll be paying a premium every month for something that might never occur. While it's always a good idea to have personal health insurance as some of those expenses can be life changing, pet insurance doesn't quite fall into the "must have" bucket in my view.
The average emergency vet visit usually costs around $800 - $1500, and if your fur baby requires surgery this could cost upward of a few thousand! Having a stash of cash tucked away just in case will avoid you going into debt to get your best friend back to peak health.
5. You want peace of mind
Probably the best reason to have an emergency fund is the peace of mind that it brings. No one wants anything bad to happen but it's just a fact of life. Knowing that you have enough savings to cover just about anything that comes up means less stress for you and your family, and who doesn't want less stress in their lives?!
We never know what life is going to throw at us, and we can't think of every emergency circumstance. That's why it's best to save a sum of money that sits on the sidelines only to be called in to play if and when it's needed.
If the thought of saving 3 - 6 months worth of expenses has you quivering in sweat and wondering how the hell you are going to get there, aim to get at least $1000 and build up to an amount that you're comfortable with. Everyone's comfortable amount will be different but the one thing that's certain is that everyone NEEDS to have an emergency fund.
Blake - FIRE with a family