If there’s one lesson that we can all take away from the COVID-19 outbreak it’s that we can’t predict the future. Yet, it’s these types of unexpected events that are the most important to prepare for. By looking at your full financial picture you can make sure you are as ready as possible for unforeseen circumstances.

It would be easy to focus solely on your investment portfolio and say that your finances are sorted but there are several other factors that can have a dramatic impact on your quality of life now and in the future. That’s why we will be publishing a series of articles on how to future proof your finances so that if there’s another market fall or economic recession due to COVID-19, or any unexpected major event, you know that you are as prepared as possible.

Why have an emergency fund?

An emergency fund is the best place to start because it’s the foundation of your finances and can go a long way to relieve financial worry. New research commissioned by the Financial Services Council in March 2020 presents a challenging picture when it comes to Kiwis’ financial stability. 70% of us would not be able to meet basic financial commitments such as mortgage/rent and bills beyond a short period of time if we lost our jobs. Over a third of us would not be able to last beyond a month. Additionally, unemployment in New Zealand is forecast to spike over the remainder of the year, and stay at elevated levels in the coming years according to a recent Treasury publication.

Source: The Treasury Budget Economic and Fiscal Update 2020, 14 May 2020

An emergency fund’s role is to be available in case of unexpected events such as:

1. Job loss
2. Car trouble
3. Medical expenses

It’s important to keep your emergency fund separate from your investment portfolio and everyday spending accounts so if you do need a significant amount of money it won’t derail your goals. It’s best to only use it when you absolutely need to, and if the funds can’t be sourced from your everyday accounts.

How much should I have in an emergency fund?

The amount varies depending on the person and family, but the general rule of thumb is three to six months’ worth of expenses. Of course, expenses vary person to person, but you can add up a rough estimate of how much you spend per month and if in doubt, round up. Some questions that might help you decide if you need more or less include:

1. How secure is your job? Is it in an industry that will likely be affected in a recession?
2. What insurance do you have? Can it help cover car, medical or other emergencies? What is are the insurance excesses that you would need to cover?
3. Will you need to help your children or grandchildren if they were to lose their jobs?
4. Would you need to support your parents if they had an emergency?

Three to six months of expenses is a good goal but having something is better than having nothing. One strategy to build up your emergency fund is to set up an automatic payment for what you can afford until you have reached your target.

Where should I keep it?

An emergency fund should be kept separate from your everyday banking so you don’t accidentally spend it and so you can look to earn a better return since you won’t be making regular transactions in this account. When looking to open an emergency fund account some of the key factors are:

1. Can I get my money out quickly?
2. Is my money safe or will it fluctuate in value?
3. Am I getting a higher return than my everyday accounts?

The whole purpose of an emergency fund is to have money available if an unexpected event happens. You don’t want to wait for something like a term deposit to mature or pay expensive break fees. Instead look for saver accounts that offer extra interest for not making withdrawals. Notice savers might also be a good option because even if you are supposed to give 90 days’ notice before withdrawing the funds, some allow you to withdraw immediately while just giving up some interest. Before signing up for an account be sure to check the features and ask how quickly you can withdraw the money if needed. You can compare and find the best rate at Interest.co.nz.

Is it possible to have too much in your emergency fund?

Yes! No matter what savings account you put it into, by leaving your money in cash earning low or no interest, its value is going down due to inflation. Inflation just means that prices rise over time. Based on an estimated inflation of 2% a year if you were to leave $50,000 in cash earning no return for 20 years it will only be worth about $33,000 in today’s dollars.

By investing excess funds in a diversified portfolio with a significant portion in equities, you are able to not only to keep pace with inflation but also grow your money over the long term. Investing in equities isn’t a suitable option for your emergency fund though. If you had invested it, then just when you potentially needed the money most (like the recent Covid-19 crisis) the value might have dropped significantly. While this isn’t a problem for long term investors who are able to stay in the market, it would be a serious issue if you or a family member had lost your job and needed that money now.

The bottom line

An emergency fund is a great first step to reduce risk and stress in your finances. Just knowing that it’s there gives you peace of mind and allows you to focus on what matters most, rather than worrying about “what-ifs”.

If you wish to discuss anything do with your savings plan or investments – talk to one of our Authorised Financial Advisers.