DISCLAIMER: This chapter references general topics, but nothing included should be interpreted as tax advice. You should see a tax adviser if considering these topics.
Life is full of surprises.
Good ones and bad ones.
Not all surprises require money, of course. But if it does, how will you cope?
We can look back at our past credit card transactions and bank records to ascertain how much we spend on a weekly, monthly and annual basis. We can budget for these planned and most likely recurring expenses - our rent or mortgage, food, transport, childcare, utility bills, Netflix subscriptions and more.
But how do you budget for the unexpected surprises?
Your car breaks down and you need to fix it urgently so you can take your Mum to her medical appointment. You lose your job (during a pandemic when no one is hiring in your field of expertise). A freak tornado takes your roof off. Or perhaps a loved one has an accident overseas and you need to urgently fly there to be with them as they lay dying in a foreign country.
The Grattan Institute, an Australian public policy think tank analysed data from Australian Bureau of Statistics survey on income and housing for 2017 - 18 and came up with these figures:
- 10% of working households had less than $90 savings (in bank accounts)
- 40% had less than $3600 savings
Looking at how this relates to working households' weekly income, the report also found that:
- 25% of working households had less than 1 week's income saved
- 50% had less than 5.6 weeks' income saved
The report's conclusion was that not many households can rely on their savings to see them through a protracted job loss.
Where are you situated in these data? Are you prepared for what life may throw at you? The good and the bad?
To help prepare yourself for emergencies, you've got to make sure you are fully equipped with all the necessary information! Specifically:
- Building financial resilience
- Emergency fund
- Insurance
- How much risk are you willing to live with?
- Do you need personal insurance if you are pursuing FIRE?
- Self-insurance
- Insurance inside superannuation
- Ways to reduce insurance costs
- Final thoughts
Building financial resilience
Saving for emergencies should be part of every FI plan.
Because we want our plan to be resilient, i.e. the ability for our finances to bounce back from a setback. We don't want to accumulate more debt to deal with our emergencies. And we definitely don't want a financial emergency to derail us from our ultimate goal of achieving FI. A delay perhaps but not be forced off course completely.
So, having an emergency fund and adequate insurances is part of my contingency plan on the way to achieving FI.
Emergency Fund
An emergency fund is basically savings that you set aside and can access quickly, specifically to deal with those unplanned and unexpected surprises.
Having a fully-funded emergency fund is empowering - you feel financially secure; you are confident you can face whatever surprises life throws at you.
There are many circumstances out of our control, which we may or may not be prepared to deal with emotionally or physically. The coronavirus pandemic is a case in point.
Not having to deal with financial woes while coping during these stressful situations is priceless.
How much do you need in your Emergency Fund?
When times are good - the economy is strong, the stock market is rising daily, you have a job - it is tempting to think you don't need much in an emergency fund. But when disaster strikes, we may regret that we haven't saved enough.
The conventional wisdom is to have enough for 3 to 6 months of expenses in your emergency fund. This will give you time to breathe, to take stock of your current situation and plan your next move.
But it really depends on your life circumstances. Questions to consider include:
How secure is your job? How soon do you think it will take for you to find another job? Perhaps you are self-employed - do you need an extra buffer if the business is going through lean times?
Are you the sole breadwinner? Do you have your partner's income as backup? Who else depends on your income?
If saving more than 6 months expenses gives you peace of mind and a good night's sleep, then that is perfectly fine. Do what is best for your life circumstances.
How will you save for an Emergency Fund?
It is daunting to think about saving 6 months or one year of expenses but it doesn't have to be done overnight. It may take you a year or more. Mine took me 19 months to build an emergency fund. Start with a goal of $500, $1000 but start, you must.
Look at every line item on your budget - is there anything that you can reduce or cut? It doesn't have to be forever. Once you have your emergency fund at a level that you are happy with, you can reintroduce those luxuries.
Any income earned from working overtime or side hustles? End of year bonus? Tax refund? Sold something on eBay? Anything extra goes straight to your emergency fund.
For me, the simplest way is to automate a weekly deduction from my pay. So, look at how much you can deduct from your regular income - and send that to a separate account weekly, fortnightly, monthly depending on your pay cycle. Set it up to be automatically transferred so you don't have to remember to do it every week. It may only be $20 per week to start but it will add up over months and years.
What if you are in a debt crisis? Should you still save for an emergency fund?
Yes, you should. Because you don't want to get into further debt if you have an emergency. Pay the minimum on all your debts and prioritise saving a $2000 fund. Once you reach this target, ramp up your debt repayment again but continue to save a smaller amount towards your fund until you reach your target.
Where will you stash your emergency fund?
An emergency fund should be readily available - you must be able to access it quickly. And it must keep its value.
To me, this is cash, cold hard cash.
You don't want to stash it in your stock portfolio, only to have it drop in value by 10% one day, up 5% the next. Yes, you can liquidate your stocks quickly and have access within 2 working days. But what if the stock market is having a bad run (pandemic, anyone?) - do you really want to sell your shares now and crystallise your loss?
Sometimes, on the journey to FI, we are very focused on optimising every dollar - what is the return on investment if I put $X here and how about $Y there? Are there opportunity costs if I just let a pile of cash sit in a high-interest savings account, doing 'nothing'?
To me, that cash is not doing 'nothing' - those dollars have a job - they are simply waiting to be deployed. I also appreciate its role in helping me sleep better at night.
High-interest savings accounts (HISA)
I prefer to stash my emergency fund in a high-interest online savings account (HISA), in a totally separate bank to my everyday transaction account. When I need the money, I transfer it online to my everyday transaction account and withdraw it via an ATM. It is just enough of a hassle that I'm not tempted to touch it for ordinary purposes.
In general, online savings accounts offer a higher interest rate as their overheads are much lower compared to brick and mortar banks. However, these days, even high-interest savings accounts don't earn much interest. At the time of writing, most offer less than 2% but the good news is that your emergency fund is safe from the volatility of the stock market.
Below is a comparison table of savings accounts with popular online banks (ING, Me and UBank) vs the 4 big brick and mortar banks:
As you can see from the above table, online banks offer much better interest rates.
The savings accounts in the above table all come with a bonus interest if certain eligibility criteria are met for the month. Each account has its own eligibility criteria. If this criteria is not met, the interest rate reverts to the much lower rate.
Most banks also offer short term savings accounts with a higher introductory rate that then reverts to a much lower rate after several months.
Choose an account that suits you and always read the fine print to ensure you know what to do to get the interest rate you want. There is no point in getting an ING account if you are opposed to using debit cards.
Don't get too wound up about the best interest rate - the important thing is to start saving and to have a system that works for you. The simpler, the better.
Government guarantee
The Australian Government guarantees up to $250 000 per account holder per authorised deposit-taking institution (ADI). This includes banks, building societies and credit unions.
But beware of different brands of banks operating under the same ADI eg. UBank and NAB or BankWest and CBA. If you have less than $250 000 combined in UBank and NAB accounts, you are covered. But if both your UBank and NAB accounts combined exceed $250 000, only the first $250 000 is protected.
This guarantee provides an extra level of security – your cash is in safe hands.
Where else can you stash your Emergency Fund?
Term deposits used to be popular, especially with the older generation. You lock your money away for a pre-determined time period for an agreed interest rate. It is inflexible - you can't add to it and you lose the interest payment if you withdraw earlier than the stated time frame. These days, the interest rates offered are not any better than online high-interest savings accounts.
Many people choose to keep their emergency funds in their mortgage offset accounts if they have one. This helps to lower your interest payable on the mortgage as interest is calculated on the difference between your mortgage and the balance in the offset account. But be aware that this amount is still owed to the bank. And when you close your mortgage account, you will need to save for an Emergency Fund from scratch.
Others have mortgage accounts that allow a redraw of excess repayments and consider this 'extra' money as their emergency fund. But beware, as banks can change their conditions any time (as in the case of ME bank recently) and 'absorb' the extra repayments which means suddenly your emergency fund is much smaller.
When will you use your emergency fund?
Define what an emergency is to you. Have a clear idea when the fund can be accessed. So you are not tempted to spend it on something frivolous.
When you do use it, make sure your most urgent priority is to replenish it to its original level.
Review and reassess
When your circumstances change, don't forget to assess if the target amount is still adequate. Has your family grown? Are you now self-employed? Alternatively, your expenses may have decreased, for example, you no longer have a mortgage.
Insurance
Life is unpredictable. Misfortune such as natural disasters, accidents and ill health can befall us at any time.
While an emergency fund of 3 to 6 months expenses can tide you over and give you breathing space, it is inadequate to rebuild your house should a fire destroy it, for example.
We may need to purchase insurance to further protect us from the financial ramifications of dealing with major misfortune. Once again, we don't want to derail our FIRE plan.
How much risk are you willing to live with?
It may seem that buying insurance is a waste of money - you are purchasing a product that you hope you will not use. Because if you do use it, it means that something bad has happened.
But how much risk are you willing to live with?
Regardless of which type of insurance you purchase, there are two questions to consider:
- What are the chances of a catastrophic event happening?
- What are the implications (financial and otherwise) if this event happened?
- Is anyone depending on your income - a spouse, children or elderly parents?
- Do you have debt?
- How far along the FIRE journey are you? How big is your nest egg?
For example, the chances of a fire destroying your house may be low but the financial ramification is large if it did happen.
Do you have enough money to rebuild your house? Where will you live while your house is rebuilt? Can you afford rent? Can you afford to replace the items lost in the fire?
Buying home (and contents) insurance and paying an annual premium of $1000 may save you forking out hundreds of thousands of dollars to rebuild your house later.
Using these two questions, will you insure your mobile phone against loss or theft? Most likely not if you can afford to purchase another phone outright (that emergency fund comes in handy here). Or perhaps you are very careful with your phone and it doesn't leave your person at all times.
Do you need personal insurance if you are pursuing FIRE?
Personal insurance is also known as life insurance. There are 4 types of life insurance –
- Life cover (or sometimes referred to as Death cover) - pay your beneficiaries a lump sum if you die
- Total and permanent disability (TPD) - pays you a lump sum if you are injured and can never work again
- Trauma insurance - pays you if you suffer a heart attack, has cancer or other major or critical illness
- Income protection - pays you up to 85% of your income for a specified period if you can't work due to injury or illness (most policies pay 75%)
Only you can decide if you need insurance, based on your life circumstances. Besides the amount of risk you are willing to live with, there are 3 more questions to consider:
In other words, what are the consequences to your dependents if you are injured or diagnosed with a major illness and unable to produce an income? Will your dependents be homeless if they can’t afford to pay the mortgage after your death?
If you are at the beginning of your FIRE journey and you have dependents and debt, then an income loss due to an injury or a major illness may put you in financial hardship.
If on the other hand, you are single with no dependents and have paid off your mortgage, you probably don't need life cover. No one suffers financially should you die.
It all depends on your life circumstances and the amount of risk you are willing to live with.
For me personally, I am not concerned about what happens after I’m dead because I don’t have any dependents and I am debt-free. However, I am terrified of being so badly injured that I may need round the clock care or expensive modifications to my car and house. Therefore, I continue to pay for TPD insurance inside my superannuation.
Self-insurance
There are some in the US FIRE community who eschew insurance and prefer to self-insure, most notably Mr Money Mustache.
The overriding question here is how big is your nest egg? Can your savings withstand the catastrophic events that may occur? And once again, how much risk are you willing to live with or pass on to your dependents?
Insurance inside superannuation
Life insurance is offered inside your superannuation - life (or death) cover, TPD and income protection, not trauma insurance. It is no longer automatic for those aged under 25 years old.
Fees are automatically deducted from your balance to pay for these insurances. Check your statement to see which type of insurance you are paying for and contact the super fund for more detail about the insurances - know what you are covered for.
If you have multiple superannuation accounts, you may be paying for multiple policies for the same type of insurance but you may not be able to make a claim under multiple policies.
Your insurances could also be cancelled if you have a low balance or the account is inactive for 16 months.
Switching superannuation funds could also jeopardise your insurance if for example, you have a pre-existing condition - the new super fund may not want to insure you.
Having insurance inside your super is convenient as the premiums are automatically deducted. The payments are not part of your budget as such but they reduce your overall retirement savings. The premiums are cheaper than those offered outside of super as the fund purchases insurance in bulk for its members. But the insurance may be generic and not specific enough for your needs.
If you choose to have life insurance outside of super, make sure you cancel those offered inside your super.
Ways to reduce insurance costs
Always read the Product Disclosure Statement (PDS) of your insurance policy and know what events are insured and what or how you will be compensated. You may be surprised as to what is or is not covered. Are you paying extra for top of the range insurance when a basic one suffices?
Most of us have a set and forget attitude with insurance. Do not automatically renew your insurance policy when it is due. Assess your needs - have your circumstances changed since the previous year?
In my case, the insurer automatically increases the sum insured for my home and contents insurance by 5% every year while premiums increase by 20%. I saved $600 by switching to another insurer, reduced the sum insured on both home and contents and increased my excess. For more details, refer to my post – Home and Contents Insurance – How I Reduced A Recurring Expense.
Check some comparison sites to make sure your policy is still competitive but be aware that not all companies list their products with a comparison site. Visit the company’s own website and obtain a quote. Then contact your insurer for a better deal or to match a competitor's quote.
A note on comparing health insurance policies - use PrivateHealth.gov.au for independent analysis instead of commercial comparison sites. This site lists every policy available on the market.
The table below notes some of the broad issues to consider and ways you may reduce your premium for common insurances:
| Insurance | Issues to consider | Ways to reduce premium |
|---|---|---|
| Home and contents | Do you need both home and contents? Eg a renter needs only contents while a real estate investor only needs home insurance Check the insured amount for building and the separate amount for contents What are the exclusions? Eg are you insured for flood or flash flooding? Are you insured for sum insured (an agreed maximum sum) or total replacement (whatever is needed to rebuild your house to the standard before the event)? | Combined home and contents – usually a discount is available Reduce sum insured for contents eg after decluttering Reduce sum insured for home to reflect rebuilding costs Increase the excess Install locks or alarm Insuring for sum insured is less expensive than total replacement cover |
| Car | Do you need comprehensive or merely third party? If your car isn’t worth much or you can live without it, you may only need third party Are you insuring for market value (car’s value at time of accident)? Or agreed value (a fixed amount decided at purchase of policy)? | Third-party property is cheaper than comprehensive Increase the excess Age – over 25s pay a cheaper premium Insuring for market value is less expensive |
| Life (or Death) | The older you are with pre-existing medical conditions, the more dangerous your job is or the more high risk your hobbies are, the higher your premium Consider stepped or level premiums – premium calculated at each renewal (generally increase as you age as the chances of you dying increases) vs a higher premium at the start | Lifestyle changes – become a non-smoker or non-drinker Cheaper within super – check amount insured Cancel policy within super if you have one outside super Reduce sum insured as your debt decreases or you no longer have dependents (grown up, employed, no longer depending on you financially) |
| Income protection | Do you have access to sick leave? Are you covered for a percentage of your salary or an agreed amount? If your salary is less at the time of injury (compared to salary at the time of policy purchase), you will be paid a percentage of the lesser salary unless you are insured for an agreed amount. | The longer the waiting period (the time you must wait before you receive payment), the cheaper the policy The shorter the benefit period (the specified time period that you will receive payments), the cheaper the policy Cheaper within super but not tax deductible |
| Total Permanent Disability | What is the definition of totally and permanently disabled in your policy? Will it pay out if you can’t do your job before disability (known as your own occupation) or if you can’t do any job (known as any occupation)? | Cheaper within super Cover for any occupation is cheaper than for your own occupation |
| Trauma | What serious injury or critical illness or cancer are you covered for? Do you have any family history of these illnesses? Can health insurance cover treatment? There are stringent criteria on diagnosis and exclusions | May be cheaper if bundled with Life insurance outside of super |
| Health | Covers hospital and medical costs not covered by Medicare Different levels – bronze, silver, gold, platinum – check which services are covered in each level What services do you need? If you are past child bearing age, do you need cover for assisted reproductive services? Extras – which services do you need covered? Can you save up for dental check ups or physiotherapy? How often would you use these services? | Extras cover is expensive if you choose to be insured for all services Increase the excess Age – some insurers offer a discount for 18-25 Lifetime Health Cover (LHC) – avoid 2% loading if you take up health insurance before you turn 30. Otherwise loading applies on top of premium for every year you are not insured after 30. |
The above table does not list every single issue to consider when purchasing insurance. Please consider your own circumstances and what is important to you.
A good resource is moneysmart.gov.au
Final thoughts
We pursue Financial Independence to attain freedom, to have choices, to be financially secure.
Preparing for emergencies by having a fully-funded emergency fund and adequate insurances help us withstand financial setbacks and ensure our FI plan's resilience, thus enabling us to be on track to achieve FI.
About Latestarterfire | latestarterfire.com
Latestarterfire began her FIRE journey at 47 years old. She writes about her wins and struggles as a late starter on her blog, Latestarterfire. She is passionate about sharing other late starters’ stories to encourage all that it is never too late to start and to learn from each other.
NOTE: Aussie FIRE is a free educational resource prepared by Pearler, with permission from the co-authors. At Pearler, we strive to make investing for your long term goals easier and fun, but we only provide general information and/or general advice. We don’t present you any options based on your personal objectives, circumstances, or financial needs. Any advice is of a general nature only. All investments carry risk. Before making any investment decision, please consider if it’s right for you and seek appropriate taxation and legal advice. Please view our Financial Services Guide before deciding to use or invest on Pearler.
