Things unexpectedly pop up in life all the time so it’s important to have some money set aside so you are prepared. Join us in today’s episode to hear about setting up an emergency fund, why it’s important, and how to treat it differently to other accounts you may have:
Cash – Asset or Tool?
In investment terms, we typically think of cash as an asset to be deployed to make more money. Sometimes the method for deploying that cash can be to keep it in a “high interest” account to see that money grow. Host Andrew Baxter explains that in times of inflation like what we’re in now, the cash is not actually working for you as an asset. You need to see returns on your money at least in line with inflation, or the increase in the cost of living just to be breaking even given that money is only worth as much as what it buys you. When you have money there for a rainy day it is no longer an asset which can be applied anywhere that makes money, but a tool with a specific purpose of covering an unexpected expense.
What is an Emergency Fund
It is unsurprising to hear that an emergency fund is simply a chunk of money set aside for when any unforeseen problems do arise. Andrew Baxter suggests focusing on this aspect of your finances once you have eliminated bad debt from your life. Things like buy now pay later debts, credit card debt, or debt on any other purchases that are not operating as investments should be settled before you make the effort for an emergency fund. The chances are that on debts like these there is likely to be fairly high interest rates which can take their toll if it takes you too long to repay them. Showcasing the ability to pay off bad debt shows that you have developed the skill for saving while also having your budget under control. The next goal is to then have 1 month worth of your expenses set aside and saved for you to use should you run into any issues. Once achieved, it is always valuable to try to stretch your goals and achieve more than you initially set out to.
What is an Unexpected Expense?
When it comes to managing money, there is little more important than discipline. Host Andrew Baxter explains that it is not for anything discretionary but strictly to keep you afloat should you find yourself in a position where money is tight. Something like urgent repairs for your car or perhaps medical bills that simply need to be paid may justify dipping into the emergency fund, but wanting a new pair of shoes or to go on a holiday probably is not a valid reason to withdraw from your emergency fund. When you have correctly used the emergency fund and once again find it empty, your next job is to figure out how to once again divert funds so that you can accumulate money back into your emergency fund. Emergencies are not always one-offs in life, so it’s better to be prepared should another one appear.
Adjusting and Reviewing your Emergency Fund
Things can change in life – you can find yourself without a job, earning more or the cost of living going up. Mitch notes that as some people begin to make more money, for example, they have a tendency to open themselves up to lifestyle inflation – spending more because you are making more. This is an easy trap to fall into but it can be costly for your long term money goals. One of the best ways to save is to spend the same amount even as you earn more and this will automatically give your savings account a boost. Also, when you find that you need to dip into that emergency fund, it’s vital that you prioritise replenishing it for the next potential issue. Emergencies can pop up anywhere at any time and just because you’ve recently had one does not mean another emergency expenditure will be popping up.