What is an emergency fund?
Overview
An emergency fund may also be known as rainy day money or a contingency pot. Whatever you call it, what’s important is that you have one.
In essence, an emergency fund is a way of planning for the unplanned. Life often throws us curve balls and it’s about being prepared for this, by having a pot of money in a savings account, which you can get to in an emergency.
What constitutes an emergency?
Everyone is likely to view this differently, but typically we would constitute an emergency as:
- A loss of income
- Essential house repairs
- Urgent car repair
- Unexpected health costs i.e. dental treatment
- A larger than expected bill
The emergency could be large or small, but it is truly an emergency where you absolutely need to find money to deal with it. It’s not being invited to a party that you haven’t budgeted for, as in this scenario you do have the option to say no!
Why is an emergency fund important?
Unplanned expenses can be pretty stressful. Mentally, knowing that you have the financial capacity to withstand an unexpected cost will give you a level of comfort that you won’t have if you hold no savings.
An emergency fund will also mean that you don’t have to make difficult financial decisions or worry about not being able to pay your bills. A choice between repairing your car so you can get to work, or paying your gas bill so you can heat your home is not a position any of us want to be in.
Similarly, having money set aside means that you don’t have to take out costly loans or credit cards to fund the expense. Paying interest on debt will not help you long term as it can be a vicious cycle to break out of.
How much emergency fund do I need?
This is likely to be based on your personal situation and what you feel you need. As a minimum we always advise having 6 months worth of income set aside. This would hopefully be enough to give you time to get back on your feet if you suffered a loss of income.
If you have sickness benefits from your employer or you have insurances in place that protect your income, this can help your emergency fund to last longer.
6 months of income may feel like a lot but can you really ever have too much in savings? For us, we’d always prefer you to be in the position where you have more than you need.
Tips for building an emergency fund
Building an emergency fund, especially if you are starting from scratch can feel like quite a challenge. If you live from pay day to pay day, it may be hard to create a saving habit. But every penny really does count, and you’ll feel significantly more financially secure by building yourself a contingency plan.
Here are some of the common strategies used:
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Set a goal
Decide what level of emergency fund you would like to build. With some online savings accounts it’s possible to set a savings goal on the account, and see progress towards that goal.
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Review your budget
Track your income and outgoings to see what exactly you are spending on. Is there things you can cut back on? I.e. That cup of coffee on the way to work every morning. Can you reduce your costs by reviewing your service plan? I.e. Use a comparison site to see if you are on the best energy deal. Is there a cheaper option? I.e. Check what interest rate you are paying on debt and if there is an alternative.
When you have done this, you should have a good idea of what it is realistic to save.
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Automate saving
Open a savings account that is suitable for you. The better your interest rate, the quicker you will achieve your goal. Higher rates are sometimes available for regular saving, and ISA’s will help you to make your money tax efficient. Once you have an account and know how much you can save, set up a transfer so this money goes out of your current account as soon as you are paid. Think of saving as being like paying a bill. This should be done first, rather than relying on what’s left at the end of the month.
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Take advantage of one off opportunities
Birthdays and celebrations are often a time when we receive gifts. As we get older, these gifts tend to come in the form of cash with the instruction to ‘treat yourself’. Instead of spending that gift on you now, treat your future self by putting some of it aside in to your emergency fund.
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Review your progress
Keep checking how much you have saved and how you are progressing towards your goal. Remember slow progress is better than no progress! Congratulate yourself on creating and sticking to a saving habit.
And don’t worry, if an emergency occurs and you need to spend some of your emergency fund. That’s what it’s there for! Just start building it back up again.
What if I need more help?
MoneyHelper is a service, providing free and impartial money and pensions guidance for people all across the UK, backed by government. You can learn more about the support they offer here.
If you’d like to know more about our approach to saving and investing or would like a free brochure please call us on 01482 275540 or, complete our contact form here.
The value of an investment with St. James's Place will be directly linked to the performance of the funds you select and the value can therefore go down as well as up. You may get back less than you invested. Equities do not provide the security of capital which is characteristic of a deposit with a bank or building society.
The favourable tax treatment of ISAs may be subject to changes in legislation in the future.
