Why You Need an Emergency Fund

Posted on 29. Nov, 2011 by in Wealth Essentials

Emergency fund

I was telling a friend about some bad luck we had the other day which ended up as an unexpected expense.  He was sympathetic and commented that it must have been the last thing we would want coming into Christmas with all the extra costs.  I had to agree with him, no one likes the added expense, but it actually didn’t hurt as much as it could have.

Last week we were unfortunate enough to pick up a big screw in one of our car tyres.  I’m still not sure how it managed to occur, but it needed some pretty quick attention so my family and I jumped into the car (the tyer was still inflated) and drove down the street to the tyre shop, which for my wife was conveniently located next to the shopping centre.

A quick check by the tyre mechanic revealed that it was not salvageable.  Pretty disappointing as it was only about a year old and otherwise in good shape.  Luckily for me they decided to do a deal on the replacement, but it still ended up costing almost $200.

Emergency Fund on Tap

I explained to my friend that we have separate accounts that we use to save for different things, one of which is an emergency fund.  It’s a very simple system (like an electronic envelope system), but it means that we never get caught out.  He thought it sounded like a pretty good idea, so I gave him a quick run down on the way we handle our money.

Generally I like to try and avoid the word budget as it often conjures up bad mental images for a lot of people and they just stop listening immediately.  Saying you have an automated system with separate accounts that your money goes into is the best way to combat this, it makes people think the idea is a bit different. Occasionally you get a clever person asking if it would be better to put all your money into a mortgage offset account, but for simplicity and the small difference it makes, I like this system better.  I have covered this before here on the site, but I know so few people that actually do it, I’m going to cover it again.

The Money You Keep

This is an important wealth creation rule.  The amount you keep (to invest and never spend) should be as much as you can afford, but go for 10% of your income as a minimum.  Treat this as a bill that you can’t ignore and pay it first.  The best way to do this is to set up a savings account called Don’t touch (or whatever you want really) for this to go into.  A savings maximiser account with ING Direct is perfect for this (the US version is here).  Later, when you have a nice stash, you can look at ways to get it working hard for you, but if you are just starting out, just set it up and forget about it.

Bills

You should be able to get a total for all of these from old bills or looking back over a bank statement, then put away an appropriate amount every time you are paid (review it occasionally when you are feeling super productive).  Use another savings account – either ING Direct or you normal banking institution (if they don’t charge fees) – and call it the Bills Account.  So now when the bills roll in, you have the money ready to pay them without even thinking about where you are going to find it.

Savings

This is not money you keep, it is money you spend on all the stuff you want.  It might also include a Christmas savings plan and should absolutely include an emergency fund.  Your emergency fund should be at least 4 weeks pay and preferably more, but you can work up to that.  Try and get to at least $500 as quickly as you can so you have a buffer for emergencies, like new tyres for the car.

If you are really bad with money, then you might like to create separate accounts (e.g. holiday, emergency fund and Christmas savings).  In fact, it isn’t a bad idea to have a separate account for any significant savings goals that you have – think new car, kids education etc.

Food and Pocket Money

These are regular expenses which should be paid from your everyday account.  Use your credit card to buy food and petrol to get rewards if you are strict and if you can pay it off in full before the end of the month.  If not get rid of the credit card and use a debit card or just take the money out of the bank.  Knowing exactly what you have to spend is the simplest way imaginable to avoid over-spending.

Get Someone Else To Do The Work

There are two ways to ensure your money gets split into the different accounts you set up:

  1. Set up a direct debit from your everyday account for the day and frequency you are paid.  The money left in there after the transfers is yours to spend on whatever you want.
  2. Get your employer to divide your pay into your separate accounts.  They may moan and groan, but if you give them all the details (account details and amounts), it really isn’t that hard and they only need to do it once.

Option 2 is a safer option if you think you might dip into your accounts.  In this case definitely don’t get a credit card and use ING Direct, as you need to transfer the money back out and wait 24hrs before you can access it – this gives you time to feel guilty and will reduce the likelihood of impulse spending.

I don’t know if my friend will implement any of this, but I think that it is a really simple plan worth sharing with those who aren’t familiar with it.  Do you have any foolproof emergency fund or money management systems that you use?

 Image by kayaker1204

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26 Responses to “Why You Need an Emergency Fund”

  1. Melissa

    29. Nov, 2011

    We used a plan exactly like this for years and loved it. I would recommend it to anyone as it is a great way to manage money.

    Over the last year we were in the situation where we had a dramatic income drop, so this had to go by the wayside. I am hoping within the next year to implement this system again as my income increases.

    Reply to this comment
    • Money Cactus

      01. Dec, 2011

      It can get tough when your income is reduced, it happened to us when we had our first child. It is great if you can maintain a small emergency fund though, even if means putting just $5 a week away for a rainy day.

      Reply to this comment
  2. krantcents

    30. Nov, 2011

    I make it automatic using a payroll deduction. I started using payroll deductions nearly 40 years ago. Learning to live on what is left is the harder part, but it works.

    Reply to this comment
    • Money Cactus

      01. Dec, 2011

      Getting it taken away before you even see it is a safe way to go and it can make it a bit easier to forget about it too.

      Reply to this comment
  3. We put money towards our emergency fund every paycheck. Our ER fund is actually something we are working on boosting this year. It is pretty fool proof I would say.

    Reply to this comment
  4. Aaron Hung

    30. Nov, 2011

    I’m setting up an automatic deposit into my ING account every week now so gotta keep telling myself that it’s a bill hehe

    Reply to this comment
    • Money Cactus

      01. Dec, 2011

      The money you keep is the most important bill, pay it first every time you get paid and pretty soon it will be second nature,

      Reply to this comment
  5. cashflowmantra

    01. Dec, 2011

    I really to build up a bigger emergency fund. Right now I am really focused on trying to get some debt paid off, but it could end up biting me.

    Reply to this comment
  6. Good, good, good advice! Emergency funds are a lifesaver! I just had an unexpected vet expense and the money spent didn’t stress me out at all because I had it covered in my emergency fund.

    Reply to this comment
    • Money Cactus

      01. Dec, 2011

      Funny isn’t it? It sucks to have those unexpected expenses, but at the same time it’s a really nice feeling knowing that you have the funds to cover it.

      Reply to this comment
  7. Good advice but don’t forget the essential ‘Worth it’ account. If you put all your money into these virtual envelopes, you need something for fun, enjoyment and the like. It doesn’t have to be big – we recently bought Cashflow from our Worth it account.

    Of course if things are really really tight, it is difficult but otherwise life can become a drudge. Our principle is to put about 5% into this account.

    Reply to this comment
    • Money Cactus

      01. Dec, 2011

      I agree that you need money that you can just spend on what you want. otherwise it feels like you are working for nothing.

      Reply to this comment
  8. AverageJoe

    01. Dec, 2011

    My favorite words: “Get someone else to do the work.”

    I’ve decided to let someone else budget for me while I eat doughnuts.

    Actually, as a guy who loves technology, it was precisely the idea of automating the budget that got me busy streamlining. Different things work for different people, but that was mine.

    Reply to this comment
  9. UltimateSmartMoney

    02. Dec, 2011

    I know some people use their HELOC as their emergency fund. I think this is not ideal but I can see that it could work. It’s not everyday you will be tapping on emergency fund… What is your thought on this?

    Reply to this comment
  10. YFS

    02. Dec, 2011

    I use a ING account for my emergency fund. It came in handy last month when I had about 5k in unexpected expenses crop up.

    Reply to this comment
  11. 101 Centavos

    03. Dec, 2011

    I suppose the cash balance in our brokerage account could be termed as an emergency fund. It’s inconvenient to “touch”, so there it sits, waiting for an opportunity.

    Reply to this comment
  12. The Jenny Pincher

    06. Dec, 2011

    Totally agree! Setting up a system for my finances has made a huge difference for me. I have always been set on the word “budget” but having a strategy and a system to implement that strategy takes the pressure off and seems to work so much better for me!

    Reply to this comment
  13. Marissa @ Thirtsyixmonths

    19. Dec, 2011

    The reason I love using ING Direct for my EF is because I can’t easily access my money. I mean, I can but it is a bit of a pain so it avoids impulse shopping.

    Reply to this comment

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