What they are and why you need one RIGHT NOW.
What is an emergency fund?
An emergency fund is an amount of easily accessible, or ‘liquid’ cash or similar investments that you have saved up, designed to protect you from going into debt in case you find yourself in unexpected financial hardship.
What that hardship could look like might look different for different people. But you should have a clear mind as to what and what does not constitute an emergency in your life. Having to cover unexpected medical bills is one example (though a good insurance plan might help prevent this) or significant repair bills for your car. Suddenly replacing an essential home appliance might count.
Although some of these things may be covered by contents, health or car insurance, there will be times in life where you just have to pay for things that you didn’t expect. Your emergency fund is a kind of self-insurance.
Suddenly seeing that dress or gadget that you’ve wanted for ages and is now on sale, almost certainly does NOT qualify as an emergency.
If you find yourself borrowing money to pay for things, particularly when you have suffered a loss of income, then you are at risk of entering the ‘debt spiral’. Without a way to pay off that credit card or loan, you in serious danger. That can be avoided, but having an emergency fund.
What you need to protect
The BIGGEST THING to protect against is a sudden loss of income. Your most powerful asset is likely to be your ability to earn. If you lose that, you need an emergency fund to protect you.
Over the course of a 40-year working lifetime, someone starting on, let’s say $20,000 with a pay rise of just 1% every year will earn about $1,000,000. Your ability to earn is valuable so protect it. Income protection insurance is one way to protect yourself, but this will probably only cover your inability to work for medical reasons. Just losing your job is different.
And even if you do have income protection insurance, there is usually a period of time till that starts to pay out. 3 months is typical. So you need to have enough cash to cover that period.
What you want to avoid is suddenly losing your income, and having to resort to credit card, or other high-interest debt, like payday loans. This will only make a bad situation worse.
How big should my emergency fund be?
The size of your emergency fund will be variable, dependent very much on your own situation. I would recommend for most people to have between 3 and 6 months worth of basic expenses saved up as cash. This will vary though, depending on your job security, life stage or personal outlook.
For some people who are almost at retirement, and/or have a very secure job (public sector for instance) then maybe as little as 1 or 2 months would be enough cash. For someone whose job is on the line, and who works in a very volatile industry (if you spend most of your time working as a contractor, then this is probably you) and you have a family to support, maybe 12 months is more appropriate for you.
As I write this, coronavirus panic is sweeping the world, and many people are losing, or about to lose their jobs. If you work in travel or tourism (as I do!) then things don’t look good. Time to do something about that.
How to calculate your emergency fund
In order to calculate the size of your emergency fund, first decide how many months’ worth of expenses you want to cover, then write it down. Fix that number in your mind, or even better, in a spreadsheet. Now we’ll work out how much you need to save.
What expenses should my emergency fund cover?
List your minimum monthly expenses, and start with the big ones. Any loan repayments. Mortgage, credit card, personal loan etc. Rent and bills. Then food and transport.
You have to imagine this really happens to you. What expenses would you get rid of? Personally I would cancel all unnecessary subscriptions immediately. Netflix and the gym? Sorry, you’re gone. Club memberships, after school activities for the kids, all of that stuff would have to go. Would it be comfortable? No, of course not. But it would be necessary.
My list of expenses I need to cover
This is my personal list. There are many like it, but this one is mine. Feel free to write down your own.
- Mortgage Payments
- Bills (Electricity, Oil, Gas, Water, Phone)
- Food & Drink
- Transport (Fuel, Tax, Insurance)
- Medical costs
- Baby and child essentials (a.k.a. Nappies/Diapers!)
- Miscellaneous cash allowance for anything we’ve forgotten
How to calculate emergency funds in different countries
Calculating this for me personally is a little tricky as we have expenses in multiple countries. If all your outgoings are in one place, that should make it simpler for you. For instance, we rent where we live but we have a mortgage on a property in a different country. That is why I have mentioned both rent and mortgage.
To try and keep it simple, I’ve divided our emergency funds up into countries. On a spreadsheet, I’ve got all the expenses down the left side, and a column for each country along the top.
|Country A||Country B||Country C|
|Food & Drink|
|Baby and child essentials|
|Total (in local currency)|
I’ve worked out our monthly liabilities in each country and have calculated how much we would need to stay afloat for 3 and 6 months in each of them. Right now, I would like to have at least 6 months’ worth of cash. Our rent is prepaid for the next 3 months anyway. I will aim to have separate pots in each country, thus reducing any currency risk.
Where should I keep my emergency fund?
Don’t keep in under your mattress. Or in your underwear drawer. Unless you’re seriously concerned about a run on your local bank, those are both terrible ideas. Keeping cash at home, unless it’s in a safe is not a sensible precaution. If you have a flood or a fire, you lose your house AND your money.
The best place to keep an emergency fund is in an easy-to-access cash savings account. As this will likely be a sizeable pot of cash, it makes sense to get paid interest for leaving it in a bank. Although the high interest offered by fixed-term savings accounts can look tempting, you need to read the small print, as you want to be able to access this cash at very short notice. Ideally, instantly.
With term deposit accounts, there can sometimes be a few days delay in getting your cash out, perhaps with having to visit a branch in person. That is not what you want in a stressful time of suddenly finding yourself without an income.
I would keep mine in an online savings account, that I can transfer into or out from, instantly. Ideally, this would be with another bank from your day-to-day accounts, to avoid your account getting frozen for some awful reason. (This is possible in the event of the sudden death of one of the account holders, or notification from an employer of your termination of employment, and you have outstanding debts with that bank.)
Realistically though, these scenarios are unlikely, and if you just have a separate savings account that is dedicated to your emergency funds, that is a lot better than nothing.
Is 6 months enough?
6 months’ worth of expenses should be enough, as for anything over 6 months, we are getting into a completely different scenario, of wholesale lifestyle change. Having said that, the determining factor is “How much do you need to sleep at night?” If your job is particularly vulnerable, then maybe you’d want more. Mine is, at the moment. (I work for an airline, and mid-2020, things don’t look great!) So we’ve decided to push the 6 months figure up to about 8 or 9 months if we can.
Having said that, if I was to be made redundant, I should get an end of service payout from my job. Although that may take a while to come through, it would definitely help. Also if we were out of work for a long time, we would probably look at serious downsizing of our lives and we would try to sell at least one property asset. It’s worth me reiterating that this is OUR plan. Yours may well look different.
6 months should be long enough to take stock and make some sensible decisions about our future, without having to hit the credit cards.
No-one can know the future. These past few months and years have shown that incredibly clearly. I do my best to plan, but at the same time, I always have in mind this sentence from the Bible.
We can make our plans, but the LORD determines our steps.”(Proverbs 16:9)
One big cost you should consider
One thing for expats to consider, in particular, is the cost of moving. We are all living somewhere that we are unlikely to remain in if we lose our reason for being there, usually our job. So returning home, or even moving to the next job, will cost something.
If you’re young (or old) and single, and live out of a suitcase in a furnished apartment, you probably can fit all of your worldly possessions in your regular airline baggage allowance.
If you’re like me, with a family and a wonderful wife who has a real flair for interior design, you sometimes sit back and wonder how your house got filled with so many soft furnishings. We would definitely need a big container to move anywhere. That won’t come cheap, and should probably feature in our emergency planning somewhere.
Personally, I’d hope to cover that with my end of service gratuity, but having an emergency fund might well fill any short term cash shortfall there, and cover the cost of the move. If we were to move in a more planned, less forced way, then, of course, we would budget for this cost in advance, but here I’m just outlining a worst-case scenario.
I hope that helps you get started on your own emergency fund. If you have any questions, please send me a message and I’ll do my best to help.