So much time and energy gets put into fancy investments and get-rich-quick schemes that people often forget the most important part of any financial plan should be a cash reserve or emergency fund, to protect you and your quality of life in the lean times.
Arguably, creating an emergency fund is even more important in retirement, particularly if the share market suffers a steep fall as investments markets can take quite some time to recover. It’s recommended that you have at least 12 months’ worth of payments.
But how do you put one of these together? Here’s some basic advice for creating an emergency fund to ensure you quality of life should the unfortunate happen.
Expenses an emergency fund is good for:
- Expenses associated with a health emergency.
- The need to travel or finance other arrangements as a result of a family emergency.
- Major unexpected car repairs.
- The failure of a major appliance.
- Large and unexpected home repairs or deductibles.
Know how much money you need
The first thing you should be doing when creating an emergency fund is figuring out the minimum amount you need each month to cover your essential expenses. To do this you need to separate expenses that are discretionary from those that are non-discretionary.
Non-discretionary expenses that you have committed to like loan repayments, rates, electricity and other bills should be considered your essential expenses. Expenses like entertainment, clothing and gifts should not be considered part of this.
Keep your emergency fund separate
When you’re creating your emergency fund, you don’t want to feel tempted to access it unnecessarily. Creating a separate account will remove the temptation to access it and you may even be allowed to get better returns through higher interest.
Celebrate when you reach your milestones.
While you obviously don’t want to be splurging, celebrating when you reach certain financial milestones can provide an effective incentive to keep going, which might just make that next tide marker a little bit easier to hit.