Save money for a rainy day - how much you should have in an emergency fund
Monday 31st August 2022
What's it all about?
This guide is designed to help you understand:
What an emergency fund is
Where to keep your emergency fund
How much you need to save
As Brits, we know all too well about rainy days. But do we know how to save for them? Having some money put aside for today can give you peace of mind for tomorrow. Although it might not be as exciting as investing, it provides you with an invaluable safety blanket if a big bill comes your way.
To put it simply, an emergency fund is a pot of easily-accessible cash that covers you against any unexpected costs. The benefit of having one is that you can dip into it at any time. It can also prevent you from falling into debt without a way of paying it back.
A recent study from the housing and homeless society Shelter revealed that one in seven adults in England - equivalent to over six million people - are worried about becoming homeless because of recent events. It was also found that 20% of renting parents were taking on debt to help pay housing costs.
Although we don’t like to imagine the worst-case scenario, it’s worth asking yourself what would you do if your boiler broke or you lost your job tomorrow. If living paycheque to paycheque, a sudden cost like a broken boiler could easily throw you into debt. It might be a scary thought but this is why an emergency fund is so important.
If you did have a big bill come your way but had a pile of cash put to one side, you could simply borrow from this pot and build it back up over time. And most importantly, you wouldn’t have to pay any interest, unlike a loan.
Figuring out where to save your money can be just as important as how much you save. As you’re theoretically saving for a cost that’s coming tomorrow, you’ll need to keep your savings in a place that’s easily accessible. Although you may technically have the money to cover the costs in other accounts or investments, some may take weeks, months or even years to withdraw from. By this time, you may receive a missed payment on your account and damage your credit score. This might limit your options when lending in the future. For this reason, Instant or Easy Access Saving Accounts are seen as the best place to keep emergency funds.
We all have a certain tolerance for risk. However, when it comes to keeping a roof over your head the stakes are much higher. When it comes to how much you need to save, most people will say you need between 3 to 9 months of expenses. Note how we said expenses and not outgoings.
In the absolute worst-case scenario of losing your job overnight, it’s possible to limit your spending to just your essentials. This is where budgeting comes in handy. Something you can learn about in our How to Budget Money for Absolute Beginners video. Click the play button below.
To work out your basic expenses you’ll need to sit down and add up all of the following:
Mortgage or rent payments
Household bills
Food
Any contracts you may have (I.e. Cars and Mobile Phone contracts)
Credit card payments
Any other costs that you can’t cancel without being charged
Once this is all added up, you now have the figure for one month’s expenses. As an example, if your expenses were £1,000 a month and aimed for a 6-month emergency fund, your target would be £6,000. If you have a high amount of credit card debt, it may be worth trying to reduce this before trying to build your emergency fund. High-interest rates can soon make paying this back extremely difficult and counteract any savings you make. When choosing how many months to aim for depends on your circumstances.
As you’re planning for the worst-case scenario, you may find it equally easy or difficult to find a new job. The more months you can afford without a steady income, the more security you have. If in doubt, always err on the side of caution. The last thing you’ll want is to run out of money and still be without an income.
And remember, building up an emergency fund will be easier for some than it will be for others. Certain methods of saving are best suited for different individuals and their circumstances. So if ever in doubt, speak to a financial advisor.
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