Life happens, and financial setbacks can arise when you least expect them. However, having money set aside specifically for emergencies - and just emergencies - can help you meet daily expenses without resorting to debt.
An emergency fund enables you to navigate unexpected situations with greater financial stability.
What is an emergency fund?
As the name suggests, an emergency fund is money set aside specifically for emergency purposes. This must be separate from your day-to-day spending money or your transaction account where you pay for routine bills like electricity, internet, groceries, and car servicing.
Emergencies may differ depending on your situation or circumstances, however, an emergency fund is typically set up for:
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Job loss or income reduction
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Illness or medical emergencies
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Carer duties
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Unexpected home or car repairs
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Financial support for family emergencies
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Natural disasters
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Urgent travel due to emergency (e.g. family illness or death)
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Any unexpected bills
Think of it like an insurance. You set aside money much like you're paying a premium, and the fund helps support and provide you with financial protection.
How much do you need in an emergency fund?
The ideal size of a healthy emergency fund balance can vary depending on your household's expenditure. A general rule of thumb is to save enough to cover three to six months' worth of living expenses. This will give you a buffer to cover the essentials if you lose your job or need to reappropriate your budget to settle an urgent and unexpected cost.
To determine how much you need to set aside, you need to work out your household's monthly expenses and multiply it by three or six - or more if you can. Don't forget to consider your unique circumstances such as your income stability and whether you have a mortgage or any outstanding debt when figuring out the size of your rainy day fund.
If you have a high level of debt or a variable income, you may need a larger emergency fund to be financially secure.
Therefore, before you save for anything (e.g. travel, house deposit, or any big-ticket expense), it's always good to build your emergency fund first. Once you've got that covered, save up for that Euro trip by all means!
How much do Aussies have saved for emergencies?
Living expenses can account for anywhere between 60% and 80% of monthly income for many Australians. This means three months' income saved up is a good buffer.
However, a survey conducted by InfoChoice found that more than a quarter (27.3%) of Aussies had less than a month's income in savings. The figure jumps to nearly a third or 30.9% of Gen X (born between 1965 and 1980), the age cohort saddled with more financial obligations like a home loan.
But this doesn't mean renters have it better. The InfoChoice State of Aussies' Savings report also found renters were twice as likely as homeowners to have one month's income or less in savings, at 43.2% versus 19.6%.
Matter of fact, one in six respondents across age demographics - from Baby Boomers to Gen Z - has less than $1,000 in savings. That equates to roughly 3.4 million Australian adults when extrapolated.
Given that everything is expensive these days, Australians are finding less capacity to save. The latest ABS data shows households only managed to save 0.9% of their income in the March 2024 quarter, the lowest rate in the last 17 years.
While the ideal emergency fund balance should be the goal, having money saved - whether that's a month's income worth or just $1,000 - is better than nothing. We all need to start somewhere, right?
Ultimately, you must aim to build a fund adequate to provide you with a financial buffer. Start by saving what you can and build your emergency fund over time - it's not a race after all.
Where to keep your emergency fund
Your emergency fund should be accessible, which means it should be comprised only of highly liquid assets you can quickly tap in an emergency.
Don't lock your rainy day savings in a fixed-term deposit, lest you want to pay hefty penalties if you redeem it before maturity. Additionally, do not invest it in an illiquid asset like a property - selling real estate in an instant rarely happens, and if they do, you're highly likely locking in a huge loss.
Alternatively, park your emergency fund in these financial instruments.
High-interest savings accounts
Savings accounts are the most common option to keep your emergency funds given they are an accessible vehicle to store your money. Our survey revealed they were the single most popular way to save, with 57.4% of the population having one as their primary savings vehicle.
Savings accounts cost nothing (if no fees are in play), continue to grow through the power of compound interest, and are available 'at call' meaning you don't need to wait or apply to withdraw your money.
To see your money grow, put your emergency fund in a savings account that offers high interest and relatively few conditions to earn said interest. You would want to accrue interest on a chunk of cash without having to deal with the rigmarole of minimum deposits and transaction requirements.
This also beats putting your money in a transaction account, which typically doesn't earn interest, or worse, under your mattress.
However, make sure to open a designated savings account for your emergency fund, separate from your other savings goals so you won't be tempted to dip into it.
Be aware, too, that savings account interest is classed as taxable income, which could come as a surprise after 30 June every financial year.
Offset accounts
If you're a homeowner with a mortgage, putting your emergency fund in an offset account could be a smart strategy.
Rather than earning interest, you save on interest since an offset account reduces the amount of interest you pay on your home loan. So while you're not using your emergency fund, you can park it in an offset account and use it to save on loan repayments. Money saved is money earned.
Funds in offset accounts can be easily withdrawn. Aside from lowering your home loan interest payments and taxable income (interest earned on a regular savings account is taxable), keeping your money in an offset account allows you to immediately access it should the need arise.
Be aware that offset accounts in home loans aren't free - they usually come with an extra fee or attract a higher interest rate. That said, ensure the benefits outweigh the costs.
Another thing to make sure of is that you'll want a 100% offset account. Not all banks offer this. So, 100% offset means if you have $20,000 in savings it reduces the interest payable on your loan size by $20,000.
Credit cards
This may be a controversial option. While you're not literally keeping money on a credit card, it could be a life raft in an emergency.
Credit cards present a quick and easy way to stretch the household budget to cover small emergency expenses. Many cards offer up to 55 interest-free days on purchases, giving you a brief period to find your footing if life throws you a curveball.
Be aware though that this doesn't apply from when you make the purchase. You have a monthly statement and a few extra days with which to pay off the statement.
If you're only keeping your card for a rainy day, you might want to opt for a basic one with little to no annual fee so you can keep costs down.
However, if your emergency requires a significant amount of money, using a credit card might not be the best option as interest will accrue if you fail to pay off your balance in full. A low-rate card could be a suitable option, however, keep in mind that other features will likely be limited.
Also, be aware that a credit card can lower your borrowing power. If you're in the market for a home loan, you'll find that a bank or lender will likely factor in the full credit limit, not just how much you put on the card every month.
How to build your emergency fund
1. Set a goal
Work out how much money you want to hold in your emergency fund, whether it's three or six months' worth of expenses. Make sure the fund covers not just your living costs but also debt repayments if there are any.
This can involve printing out your bank statement and physically highlighting all your expenses in a given month, and multiplying it by three to six.
2. Set up automatic transfers
Take advantage of the automatic transfers on your savings account, and set it up so that a portion of your wage from the account it's paid into goes automatically into your emergency fund. This will allow you to set and forget, knowing your fund is growing without too much effort and oversight.
3. Don't dip into your emergency fund
If you are ever short on cash on a night out, it can be tempting to dip into your emergency fund to help you get by. A new phone release or a spontaneous trip with friends also doesn't constitute an emergency!
Making a conscious effort not to use your emergency funds for non-emergency purposes can help build the balance quicker.
It could be a good idea to keep these savings in a totally different institution from your regular spending account. Better yet, make it harder for you to dip into it like storing it in a savings account with no physical debit card available.
4. Keep adding to your emergency fund
If you receive extra money during the year, like a tax refund, you can use this to boost your emergency savings. If you have no debts to pay off, direct all your savings to the emergency fund (or whatever is manageable) so you can build the balance quickly.
Life throws everyone a curveball. Having a steadily growing emergency fund set aside could make all the difference when you need it most.
5. Shop around for high-interest savings accounts
Compare savings account rates using comparison tables to find those that offer high bonus or introductory interest rates to maximise the growth of your emergency fund. It's helpful to pick an account with minimal conditions or steps you can realistically achieve to get the best interest rate.
If you put it in a transaction account earning no interest, inflation could eat away at the purchasing power of that lump sum. At least, by putting it into a savings account you're making that money work for you.
An earlier version of this article was written by Jacob Cocciolone
Header photo by Freepik
In-text photo by Towfiqu Barbhuiya on Pexels
