Personal Finance

Savings Reserves: How to Preserve and Enhance an Emergency Fund

Highly Useful: Reserve funds are more nimble yet less powerful than an emergency fund.

Having an emergency fund is not an uncommon financial milestone. Advice seems to vary, but realistic suggestions of 3-8 months living expenses in a savings account seem reasonable, depending on the probability of an ’emergency’ and the regularity of your income (e.g. salaried work vs contract work, well maintained house and car vs an older home or car in need of frequent repairs).

My response to this had been to have 6 months living expenses (around $10,000) at hand in an online savings account. And just as well. This month I’ve had to make several transactions on short notice amounting to around $3000. Had I not had an emergency fund, I would have called on my credit cards and been pinned to interest repayments for the next 5-10 months – not a pretty picture (update: this happened anyway, but I finally no longer owe any credit card debt!).

What frustrated me a little was that I dipped into this fund for semi-discretionary purchases. One purchase I made was a refurbished MacBook Air after my MacBook Pro failed and was eventually deemed irreparable; I fought to fix it for months, replacing parts before biting the bullet when I was told the repair also required a new logic board (~$900). As a PhD student and lecturer, going with out a computer is difficult, but not impossible (update: ended up finding the faulty part, replaced it and sold the laptop second hand).

I started thinking about the use of an emergency fund. What’s it’s purpose in the context of building wealth? Do they lock up too much of our savings and limit wealth accumulation, especially for the lower income earner ($10K seems like a lot!)? How much is enough? What constitutes a true emergency? Once you have an emergency fund, is that it?

I’ve learned a few things about having an emergency fund and about my own personality:

The importance of a reserve fund. The temptation to use money from your emergency fund for semi-discretionary purchases that aren’t quite emergencies but which are unplanned is high. Be aware of this and cordon off the emergency fund. One way to make this easier is to set aside a small amount (e.g. $2000-3000) for unexpected semi-discretionary purchases (e.g. that new laptop) and keep it in a separate savings account.

What’s a good balance for an emergency fund?

3 months expenses is probably enough as a minimum – I think this is about the sweet spot between a meaningful buffer to many emergencies (car repairs, home repairs, reduced work availability) which can be added to monthly, creating a more significant buffer. For many people, saving 6+ months of expenses is not just unnecessary, it’s also intimidating. I had over $10K saved, and it was probably more than I required. By starting smaller, the goal is more attainable and removes some of the stress of saving early on. My aim is to start with 3 months expenses in reserve, and add small amounts to it there after, slowly building up to 6 months of expenses in the emergency fund.

Personality is important. I’m quite risk averse, and prefer 4-6 months living expenses in the fund. Four months living expenses seems like a good minimum balance for me, and I’d sleep soundly with that.

What this means for me is that I’ll now be accumulating a small amount for a reserve fund to act as a buffer prior to dipping in to the emergency fund. I’ll also be replenishing my emergency fund to $8000 ahead of other financial priorities (i.e. investing) and building on it steadily from there to $10000. Whilst my net worth has taken a hit, I’m glad I followed the advice to have an emergency fund and with these few tweaks, have probably learned to manage my reserve funds more effectively.

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