Do I REALLY Have to Save an Emergency Fund?
- Consider what kind of (and cost of) emergencies that could happen
- Assess your current financial situation
- Weigh up peace of mind vs opportunity cost
- Decide on size of emergency fund
- Work out a savings plan and do it!
Unless this is the first personal finance article you have read, you will be familiar with the recommendation to have 3-6 months expenses (or more!) saved in case the unexpected occurs.
The Barefoot investor calls it “Mojo” to make it sound more interesting. Being able to cope with unexpected financial setbacks is an essential pillar of financial security.
But if you are desperate to get your debt under control, or itching to dive into investing, saving for an emergency fund is slow and frustrating. The White Coat Investor and other high profile US physician bloggers feel they don’t need an emergency fund.
So do you, as a doctor, really need an emergency fund?
What Types of Emergencies Could Affect You?
This is very variable depending on your situation. What sort of emergencies could happen to you or your household?
Do you own a house? Large house repair eg Replace water heater or major roof leak $5000-$10000
Do you live far from extended family? – Flights home and time off work in case of that dreaded family member emergency
Do you have sick leave accrued and own occupation income protection? What is your waiting period and duration of payment (2 yrs vs until 65)? If you were too ill to work would you need to cover expenses with savings?
How secure is your income source(s): Do you have a permanent or temporary contract if employed, work as a locum or private practice? Is there another income earner in the household?
Do you have dependents?
How much are your monthly expenses? If you had to cut all the fluff, how much would you need for your household to make mortgage/rent payments, pay for food and utilities, school fees and other essentials?
Do you have negatively geared property? Or leveraged investments that could be margin called in a market crash?
What is Your Financial Situation?
Are you already in debt? I wouldn’t count HELP, as this does not need to be paid if your income stops. But if you already have credit card or Afterpay debt that isn’t paid off monthly, you’re in a vulnerable position.
How much surplus income do you save per month? Is it enough to cover emergencies anticipated in a single month?
How much extra do you have sat in your mortgage? With a redraw facility or HELOC this can be considered your emergency fund if sufficient
How much tax to be paid is sitting in your account for most of the year? Due to effective tax planning, I plan to always have around several thousand dollars in my “Tax to be paid” account, offset against my mortgage. This could be used short term in an emergency, and re-earned before tax is due. I earn the next year’s ABN cash before I have to pay the last years tax.
Do you have a buffer(s) in your everyday account(s) or offsets? Kids savings account that (at a push, and temporarily) could be used to get you out of trouble?
Peace of Mind Vs Opportunity Cost
The White Coat investor is financially independent, with multiple income sources. Having tens of thousands of dollars earning 2-4% in a “High interest” savings account or mortgage offset account is inefficient in comparison with long-term investing returns. If you have income far in excess of your expenses, perhaps an emergency fund is unnecessary.
Three years ago, our car died dramatically. My partner was stuck in a dusty somewhere in the middle of nowhere. Myself, 1 and 4 year old had flown home in luxury. My partner was hundreds of thousands of kilometres away, hostage to the nearest tow service and car mechanic. It cost $10,000 to get my partner home on Christmas Eve (to our childrens’ delight), and of course the car has never run right since.
For most of us, some kind of emergency fund seems prudent. But you may have enough cash that is lying around anyway that you don’t plan to spend and can double as part or all of your emergency fund.
I have a buffer in my everyday account in case my employer forgets to pay me (it’s happened) or expenses going out are larger than expected), $2000 in a “house” account to cover replacing broken appliances and extra mortgage repayments that could be withdrawn. I also have my “To be paid” tax sat in an offset and some kids’ education savings sat in an account earning 5% that could be quickly access in a real emergency.
If you’re just starting out, you likely don’t have money “just lying around’. The priority is paying down consumer debt, in my opinion. there is no point in saving into an emergency account paying 2-4% if your outstanding credit card debt is charging interest over 10%. In this situation, I think you’re stuck using the credit card as your emergency fund until you have paid it off.
If you have a mortgage, the easiest and most efficient place to park your emergency fund is in an offset. A redraw is also reasonable.
If you don’t, you’re stuck with a “High interest” savings account. The easiest, simplest and lowest risk choice is to find an account with $0 fees, and a reasonable interest rate. At the time of writing ME Bank offered 2.2%.
If you can be bothered opening multiple accounts, its possible to get a slightly higher interest rate (2.6% currently) for an introductory period – and move your savings from one bonus introductory account to another every few months.
If you have several months of pay saved up in case of emergencies because you have unreliable or lumpy income, term deposits or even a bond index may be worth looking in to for the savings not required immediately.
Unless you are financially independent, or have monthly surplus in excess of the cost of potential emergencies, I believe some sort of emergency fund is wise. Going without really does seem to be tempting fate!
Sit down and work out how much of your income, below is a table to use as a starting point.