Investment guide

Building an emergency fund with term deposits

While many expenses and changes in life can be planned there’s no doubt life can throw you curveballs. From unexpected bills to car breakdowns, emergencies can put a strain on your finances. An emergency fund acts as a financial safety net, providing peace of mind and the resources to weather unplanned expenses. While a savings account is the traditional choice, term deposits can also play a role in building a strong emergency fund strategy for a rainy day.

Why consider term deposits?

They can be a valuable tool for building an emergency fund. Here’s some key reasons why:

Higher interest rates

Term deposits typically offer higher interest rates compared to regular savings accounts. This means faster growth for your emergency fund, giving you a greater buffer when faced with unexpected expenses.

Reduced temptation to spend

Your money is locked away for a predetermined period (usually a few months to several years). This can be a great way to avoid the temptation of dipping into your emergency fund for non-essential purchases.

Fixed returns

Regular savings account rates can fluctuate, whereas a term deposit investment offers a fixed rate with a predictable return on your investment. This stability can provide peace of mind allowing you to grow your emergency fund with greater certainty.

Lower-risk investment

They are generally considered a lower-risk investment when compared to other investment options. They’re unaffected by market ups and downs so you know your money is protected.

The potential drawbacks

While term deposit investments offer some good advantages, they also come with limitations that need consideration.

Restricted accessibility

You are unable to withdraw your money without possible penalty during the agreed term of your investment. This can be problematic if an emergency arises sooner than anticipated. Early withdrawal penalties can vary but often involve forgoing some or all accrued interest, potentially negating the benefit of the higher rate.

Minimum deposit requirement

They typically require a minimum deposit amount to open, which might not be feasible for someone trying to build their emergency fund from scratch.

Inflation risk

While they offer a degree of protection for your emergency fund from market movements, the interest rates on offer may not keep pace with inflation. Over time this could lead to a decrease in the purchasing power of your emergency savings.

Finding the right balance

Here's how to strike a balance between accessibility and growth potential:

Split your fund

Consider a hybrid approach to growing your emergency fund. You can allocate a portion of your emergency fund to a high interest earning bank account for easy access to cover minor unplanned expenses.

You can consider using term deposits for the remaining amount, allowing it to grow at a potentially higher interest rate. This ensures you have readily available funds for immediate needs while maximising growth on a larger portion of your emergency savings.

Choose shorter terms

Think about choosing shorter terms (such as 3-6 months) for your emergency fund. This provides a good balance between accessibility and potentially higher interest rates. Knowing you can access the funds within a reasonable timeframe can provide peace of mind, while still allowing you to benefit from potentially higher returns compared to traditional savings accounts.

Building a strong emergency fund is important for financial security. While a savings account might be the first thing that comes to mind, a well-rounded emergency fund often involves a variety of tools. By using a combination of savings accounts and term deposits, you can build a safety net that allows you to face life's unexpected events with confidence.

How to build your emergency fund with term deposits

1. Set your goal

The ideal emergency fund value varies based on a range of factors including your financial situation and lifestyle. Determine the total amount you want to save to build a safety net that works for you.

2. Choose the split

Decide how much to allocate to your savings account and term deposits, considering your comfort level with restricted access.

3. Shop around

Compare interest rates across different banks and financial institutions for both savings accounts and term deposits. This ensures you find the option that best suits your needs and maximises your emergency funds' growth potential.

4. Automate savings

Set up automatic transfers to your savings account and consider autorenewal of term deposits for consistent emergency fund growth.

Frequently asked questions

Are term deposits a good option for emergency funds?

Term deposits can be a valuable tool for building your emergency fund, as they usually offer higher interest rates than traditional savings accounts. This allows your emergency savings to grow faster. However, the limited accessibility due to the fixed term can be a drawback.

Can I access my money in a term deposit if an emergency arises?

Early withdrawal from a term deposit typically incurs a penalty, which may negate the benefit of the higher interest rate. Consider combining a term deposit with a high-interest savings account for easier access to a portion of your emergency fund.

What term length should I choose for my emergency fund term deposit?

Consider choosing a shorter-term deposit (3-6 months) for a balance between higher interest rates and accessibility.

Should I put all my emergency fund savings in a term deposit?

No. While term deposits typically offer higher growth potential, consider keeping a portion of your emergency fund in a savings account for easy access to cover minor emergencies. This ensures you have readily available funds for unexpected situations without penalty.

What are some alternatives to term deposits for my emergency fund?

While a savings account is the most common option for emergency funds you might want to consider other investment options, such as stocks or managed funds. Choosing the right tools to build your emergency fund depends on your needs and financial situation.