How to Prepare Yourself for a Financial Emergency

April 30th, 2019

Almost one in three Australian families are financially stressed, according to a 2017 survey of more than 1000 Australian households. Chronic financial stress of this nature can place a heavy emotional toll on individuals, and can be completely debilitating.

Financial emergencies can take many forms – a broken down vehicle, unforeseen medical expenses or even vet bills, and can present seemingly impossible barriers to financial security. For the unprepared, emergencies like this can often result in debt, exacerbating financial stress further.

It’s not all doom and gloom, though. Thankfully, planning and budgeting for financial emergencies is actually pretty simple. Follow these simple tips, and you’ll be well on your way to financial security.

What is a financial ‘emergency’?

Depending on the degree of financial stress you’re under, financial emergencies can take on a lot of forms. For those of us with significant debt, such as mortgage repayments, financial emergencies such as a short period of unemployment, or a large unexpected expense, can quite easily fall into the category of ‘financial emergency’. A simple definition might be any event which will leave your bank account in the red for an extended period of time.

Examples might include:

  • Sudden unemployment
  • Chronic illness of yourself or a dependant
  • Unexpected long term costs, such as increased mortgage repayments
  • Other types of emergencies, such as damage to your home or livelihood

Obviously, if you’re financially prepared for these eventualities, then they’ll be significantly less stressful, and you’ll avoid incurring debt or other financial difficulties as a result.

The best way to avoid this type of situation is creating an ‘emergency fund’ as part of your family budget.

Seperate your emergency fund from your other bank accounts

Keeping your money divided up into purpose made bank accounts is the easiest way to ensure that you don’t accidentally go digging into your savings. While the simplicity of having just one ‘big pile of cash’ savings account might seem appealing, it is at odds with the nature of your savings goals. Some savings goals are short term – such as for a new television or surfboard – while others are long term, like for a new car, or a deposit on a house.

In contrast, your emergency fund isn’t a savings goal per se. It’s more like insurance, protecting you in the event of an unexpected financial emergency. With this in mind, it makes sense to have a totally separate, high interest savings account, specifically for your emergency fund.

Set a savings goal 

A good rule of thumb is that your emergency fund should amount to around three months pay. While this might seem like a lot of money to just have sitting around, it actually makes a lot of sense. According to the Australian Parliamentary Library, the average duration of unemployment for Australian jobseekers classed as ‘Long Term Unemployed’ is almost two years. It is estimated that as of January 2016, there were over 200,000 of these job seekers in Australia – that’s more than the population of Townsville.

Making sure that you have enough money to cover living expenses for at least long enough to take advantage of social safety nets or unemployment insurance is vital – and the larger your emergency fund is, the more secure you’ll be.

The trick to building an emergency fund of this size is taking a slow and steady approach.

Simply allocating a small amount of each week’s paycheck is probably the easiest way to take advantage of this strategy. $25 per week is $2,600 over two years. Double your weekly addition for a total of $5200 – and so forth. Over time, your emergency fund will grow, and with it, your degree of financial security.

How else can we plan for financial emergencies?

Once you have your emergency fund set aside, it’s important to keep it topped up. Increasing it to six months worth of living expenses, or even more, is probably a good first goal.

If you feel like you need even more security, or you are anticipating a need to start tapping into your emergency fund, you might want to consider other strategies.This might include shopping around for home insurance, redundancy insurance or even investing in alternative revenue streams, such as a small business or investing in the share market.

If you are concerned about the effects of inflation on your nest egg, you might consider splitting your fund into two elements: one portion in a high interest saver, and the other in an easily accessible higher interest managed fund.

Ultimately though, cash is king. When push comes to shove, financial emergencies are often best resolved with easily accessible, liquid cash. Taking the time to prepare a budget that will allow you to have a back-up fund will save you stress, hardship and difficulty in the long-run.

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