Earlier this year I had to fly overseas unexpectedly to see my best friend who was seriously ill. It was a stressful situation for many reasons, but fortunately money wasn’t one of them.

Thanks to my emergency fund, which I set up exactly for scenarios like this, the question of “Can I afford to go?” wasn’t even part of the equation. I knew I had to go no matter what and used my fund to make it happen.

An emergency fund or rainy day fund should be one of the first steps in your financial journey. Once you have built a safety for any unexpected event, then it makes sense to focus on saving and investing.

What is an emergency fund?

An emergency fund is money that you have saved and set aside for when something unexpected happens in your life:

• Your income could drop unexpectedly and no longer cover basic expenses
• A family member might get ill and you want to help with medical bills
• Something might need to be repaired or replaced–your house, car or appliances
• A friend or relative could get very ill and you may want to fly out to be with them.

A sudden event can easily derail your financial life and make it difficult to recover. You want to avoid debt at all costs, so having a good emergency fund stashed away helps ensure that you don’t get knocked off your feet in tough times.

I hope you’ll never have to use it but you’ll feel better just knowing it’s there. Just in case.

Remember an emergency fund is not for a family vacation, a new TV or any other non-essentials.

How much emergency fund do you need?

Experts recommend setting aside around three to six months of household expenses. That’s a solid starting point, but the right amount really depends on your situation.

There’s obviously no limit to how much you could save for a rainy day. If you feel more secure with a year’s worth of expenses, that’s also fine but it’ll take more time to save up.

It’s worth thinking about the balance between too much and too little to land somewhere in the middle.
If you have too little in your emergency fund, you might not be able to cover expenses when you need to, which defeats the purpose of your emergency fund.

If you have too much, you’re potentially tying up spare cash in a low-interest account that could do you more good in other places. For example, by investing in growth stocks with a better return long-term.

Your budget can really help with this step and guide you in the right direction.

Where should you keep your emergency fund?

The main purpose of your emergency fund is quick access to that money, should you ever need it. This is why it’s a good idea to keep your savings in cash you can easily access like a long-term savings account. A short-term term deposit could work too. Just remember that you might face fees if you need to withdraw early.

You might be tempted to invest that money instead for a better return but that’s really not what your emergency fund is for. How would you feel if your savings halved in value at the time you most need them?

Instead it’s worth focusing on simply getting the best interest rate you can from a savings account. I encourage you to keep this money at a different bank for a couple of reasons:

• It keeps it separate from your other accounts, so you’re not tempted to use it for random stuff
• Your bank might not offer the best interest rate. Don’t be loyal and shop around instead

Check out interest.co.nz for the rates offered by different banks.

Make sure that your cash is held in institutions that are covered by the Depositor Compensation Scheme (DCS). This ensures that your money is protected up to $100,000 per institution, no matter what happens to it.

For me, just a little over three months of expenses feels right at the moment. I base it on expenses instead of income since I’d naturally cut back on anything that’s not essential if things went pear-shaped.
I also prefer keeping my emergency fund in a savings account instead of a term deposit because you usually can’t access term deposits instantly without penalties.

Start your emergency fund

Start small with an automatic transfer of $20 a week or whatever you’re comfortable with. As long as you start.

Even a small emergency fund is better than no emergency fund at all. Over time, that small habit will grow into the safety net that gives you peace of mind when life surprises you.