What is an emergency fund?
An emergency fund is a freely available cash cushion for unforeseen expenses. Its purpose is to be able to absorb short-term financial burdens without having to resort to expensive loans or long-term investments.
The origin of the emergency fund
The idea of the emergency fund dates back to the 16th century. At that time, Duke Julius of Brunswick-Wolfenbüttel required all of his citizens to hold a certain sum of money for unforeseen emergencies – the so-called Notpfennig ("emergency penny"). The penny later became the groschen, and so the idea of the emergency fund (Notgroschen) had already emerged more than half a century ago in Germany.
When does an emergency fund make sense?
An emergency fund is meant to help you cover suddenly arising costs quickly and easily in a wide variety of situations. In the following cases in particular, it is worth having an emergency fund ready:
- Repairs to household appliances: Whether it's the fridge, the washing machine or the cooker: in many households these appliances are essential and have to be repaired or replaced quickly if they break down.
- Faulty electronic devices: A broken mobile phone causes considerable disruption these days and usually has to be replaced immediately. For the self-employed, a damaged work laptop can quickly have adverse effects.
- Car costs: Insurance does not always cover all the costs that can arise on a car at short notice. Anyone who owns a car should always reckon with additional fees or costs for repairs and maintenance.
- Unexpected additional payments: Annual statements for electricity or heating can result in additional charges, which can be paid immediately with an emergency fund. Possible additional payments to the tax office can also be settled straight away this way.
- Damage to your own home: Unforeseen events, such as a broken heating system in winter, require a certain financial cushion in order to settle the costs as quickly as possible.
- Additional health and medical costs: While health insurance covers many costs, some health services such as dental treatment or the cost of visual aids can nevertheless involve high out-of-pocket contributions. A financial reserve is advisable, particularly in the case of serious illness.
- Unemployment or short-time work: If you resign of your own accord, you can be barred from unemployment benefit I (ALG I) for up to 12 weeks. And even if you do receive ALG I until you take up a new job, it amounts to only 60% of your previous net salary.
These are just a few cases in which an emergency fund saves you from needing an expensive loan at short notice or having to draw on other financial reserves such as fixed-term deposits or your securities account.
As a general rule: people who provide financially for family members usually need more financial reserves than singles. Responsibilities arising from a property or a car also increase the risk of expenses arising suddenly. Of course, this cannot be generalised, and the ultimate size of the emergency fund is as individual as each person themselves.
How should I invest my emergency fund?
Above all, your emergency fund should be one thing: available at all times. So you should invest it in such a way that you can access the money without any waiting period (e.g. fixed-term deposits) or loss of return (e.g. shares or bonds). A current account is less suitable for this, as your money there is generally not paid any interest. So that your financial reserves are not “eaten up” by inflation over time, an instant-access savings account (Tagesgeld) is recommended for your emergency fund. It offers stable interest and immediate availability of your assets.
As a further option, you can also use so-called money market ETFs for a higher target return. Such ETFs invest in interest-bearing securities with very short maturities. The returns you can expect are based on the ECB's key interest rates and are therefore usually higher than standard instant-access savings rates. Because of the short maturities, expiring investments are quickly replaced by securities carrying the current interest rate. Money market investments therefore adjust very quickly to the general market interest rate level – price fluctuations are consequently usually very small. Money market ETFs are also quickly available to you when needed. With Cash-Invest, quirion offers a whole portfolio of various money market ETFs in the form of a managed investment.
Why not use money from your securities account?
If you have a securities account and, for example, are invested in a globally diversified ETF portfolio, you should never use it for short-term expenses. Such an account primarily serves your long-term wealth building. Spontaneous sales (outside your long-term investment goals) are usually at the expense of your return.
How do I build up my emergency fund?
If you don't yet have a larger sum of money available for your emergency fund, you can build it up bit by bit, for example with an automated savings order. To build up an emergency fund effectively, proceed as follows:
- First, decide how much you want to save up as an emergency fund.
- Open an instant-access savings account (Tagesgeld) or a Cash-Invest managed investment, if you don't already have one.
- Work out how much you can set aside each month for your emergency fund.
- Transfer this amount consistently to your instant-access savings account at the start of the month. The most convenient way is to set up a standing order with your bank for the transfer, so that you automatically stick to the plan.
- Build up your emergency fund this way until you have accumulated the financial reserve you want.
To build up your emergency fund, you can of course also use additional income such as bonuses, cash gifts or refunds. That way you reach your savings goal even faster.
Emergency fund: how important a financial reserve is
Whether it's a broken fridge or bridging the gap until your next job: with an emergency fund, these situations no longer throw you off balance. You can set the size of your emergency fund precisely so that your financial reserve fits you exactly. If your emergency fund is held in an instant-access savings account, you can access your cash reserve at any time and also earn interest on top.
For a chance at higher returns, you can also use Cash-Invest instead of an instant-access savings account. Here too, your emergency fund is quickly available to you when you need it. You are then invested in securities, but due to the special nature of money market instruments, the price fluctuations are usually minimal.
In the end, one thing matters above all: your emergency fund is there to make sure you can sleep soundly at night.
