Avoid too much or too little in an emergency fund
When bad things happen, having access to cash to help can, at times, be a literal life saver. And even when it’s not life or death, being able to cover extra costs rather than resort to borrowing will make your life and finances much better in the long term.
So how much do you actually need? Here’s what you need to know.
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Why have emergency savings
We’ve all had scenarios where an unexpected cost has come up. These can be big and small, and they’re often unavoidable and need paying now.
If you don’t have enough money coming in each month to cover them, or aren’t able to make any required cut backs, then you will need to borrow to afford them.
You might be able to get this with no interest added via a 0% purchase credit card, interest free overdraft buffer, or even Buy Now, Pay Later, though these delayed repayments still need to be covered.
But if you can’t, you’ll have little choice but to use more expensive debts. Overdrafts tend to sit around the 40% mark, while credit cards aren’t far behind. If you then can’t clear these quickly, the debts can build up.
The bigger the emergency, the more expensive it’ll be – unless you have the savings set aside to cover them. So, if you can, it’s vital to build up a protective balance, just in case.
This is almost your top savings priority. So add money to this fund before things like investing, pensions or overpaying your mortgage.
Types of emergency
Often people just think about mid-size emergencies. These could easily be a few hundred quid a go, from new tyres for a car to a broken fridge. These are the types of costs that are half expected at some point, but you don’t quite know when. You’ll likely need to pay as soon as possible since going without can have a sizeable and immediate impact on your life.
Not all unexpected costs in this range will count as emergencies. Our dishwasher packed up last week, but that’s an inconvenience which, if we didn’t have the funds available, we could have done without for a while.
Then there’s the next level up. These are hard to predict, but can cost a lot more money, potentially thousands. We’re talking here about one-offs you might not expect at all. So a storm means you need to get your roof retiled, for instance. Or your boiler breaks.
For me, an emergency stay in hospital for my dad, hours away from his home, meant covering the cost of hotels, trains, taxis and more for more than a week so I could be there. I split the costs with my mum, but my half added up to £1,250. A real emergency, and totally unexpected.
Finally, there’s the kind of emergency that could last for a sustained period. This is where you or another key contributer to household costs aren’t able to earn an income. That could be losing your job, it could be illness.
In this time, the emergency costs become all those daily essentials – your rent or mortgage, your Council Tax, your utilities and more. If you don’t pay these the consequences could mean you lose your home or power. And some “priority debts” could also lead to bailiffs, fines or even going to jail.
What your emergency fund needs to cover
You’ve now got an idea of the types of emergency you’ll want your fund to protect against. But obviously it’s hard to calculate what will actually happen to you, if at all, and how much it’ll cost. So you can’t mitigate for everything.
Instead use your essential regular costs as your baseline. These are the ones you’d need to cover if you did lose your income. Don’t forget things like groceries and petrol or transport. Forget luxuries, focus just on what you will need to survive.
If other emergencies come up then you can use this cash for those, then rebuild by saving more once the cost has been paid for.
When not to have an emergency fund
Having said it’s vital to have a buffer to cover emergencies, it’s not worth it if you already have expensive debts. I’m not talking here about a mortgage, or things on 0% (though you’ll of course need a plan to pay those off).
Instead it’s those credit cards, overdrafts and loans that are costing you a lot of cash every month. It’s better to use all your spare money each month to clear those as fast as you can instead.
The logic is the existing debts are costing you money now, where as any future emergencies are theoretical. They might not happen. So you’ll be a far better position to deal with them, if they happen, if you have already wiped out what you currently owe.
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How long do you need to cover expenses?
A good rule of thumb is to have an amount saved to pay for three to six months of essentials. That should, in theory, give you time to get a new job or get better if you’ve been ill. Though I think it’s great to aim for the longer six months period, you might feel comfortable with less.
Depending on your own situation, you might even want to have more. If you have an irregular income, perhaps a freelancer, then there could well be spells where you don’t earn anything for a longer period. And that’s without larger crisis such as the pandemic where so many self-employed missed out on furlough.
Retirees should also aim for more. If some of your pension is still invested, then you’ll want to avoid being pushed into drawdown if the market is unfavourable.
But this is all assuming you can easily save these amounts. If you are already on a tight budget that might mean there’s little to put aside. That’s fine. Better to have something rather than nothing. For those who qualify, the Help to Save scheme can get you 50% interest on small amounts, really helping you for when those emergencies come along.
Calculating your emergency fund target
Once you’ve worked out how much you need for a month of essentials, multiply that by how long you want to be covered for. This gives you the target you should be aiming for.
So if you need £1,500 a month and you want it for six months, you’d need a total of £9,000.
It can help to have different thresholds that you can work towards. So target one could be a single month, at £1,500 in our example. Then go for three months worth, but you could also be saving for a separate goal at the same time, before pushing towards the six month figure.
Where to keep your emergency fund
The big rule here is to keep it separate to your main bank account. Doing this stops you dipping in with everyday expenses, while also letting you track your progress as you build it up.
It’s important that at least some of this money is in an easy access account. This means you can make withdrawals straight away if an emergency comes along. Look for the best possible interest rate on our savings best buy tables.
If you have a larger pot, you might want to look at locking some of the money in short term fixes or notice accounts, but that’s only really if the interest rates are significantly better than elsewhere.
How to build your emergency fund
Work out those essential costs for the coming month, and see what you’ve got spare. Then move a chunk of that across to a separate savings account
Rather than wait until the end of the month to put any spare cash aside, start when you get paid instead. Work out what is left after essentials, then decide how much of the rest you can afford to save. Ideally set up a standing order to move the same amount each month.
You can then top this up if there is anything remaining before the next payday, or use autosaving apps to add more without really noticing.
Other ways to protect against emergency
When it comes to bigger emergencies, then you can also protect yourself by looking at income protection insurance, or life insurance and critical illness cover.
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