As the world reels from the unprecedented financial chaos caused by the COVID-19 global pandemic, money matters have never been a more pressing concern.
This economic collapse is causing even the most financially stable of families to think about money in a new way.
More than ever, it is demonstrating the need for everyone to have an Emergency Fund.
You might think, ‘oh, I’ll start saving for an emergency fund when I can afford it”. But the truth is, you can’t afford to not have an emergency fund.
It can save you and your family from huge financial stress when you are at your most vulnerable.
It can stop you from taking on debt, or getting further into debt.
It might mean the difference between cancelling a long-looked-forward-to family holiday, or not.
It’s just that important.
What is an Emergency Fund?
Simply put, an emergency fund is cash put away in a savings account, that you purposely set aside for life’s emergencies.
An emergency fund gives you financial security; a safety net against any unexpected events in your life.
Of course, that includes a global pandemic, but could also help you in times of illness, when the boiler breaks down, job loss or other unforeseen emergencies.
An emergency fund is not for holidays, clothing sales, or as an excuse to have a blow out at the pub!
It should only be used when you are in a real financial bind, when you cannot afford to pay for the emergency out of your usual monthly income.
Why do you need an Emergency Fund?
As our current global situation is so adeptly demonstrating, you can’t predict everything that is going to happen. Life has a series of twists and turns, and you simply don’t know what is coming up around the bend.
The boiler might break down in the dead of winter, your company might file for bankruptcy, or the car might fail its MOT. Do you have enough money set aside to cover these things?
If not, you need an emergency fund. Give yourself the peace of mind that no matter what life throws at you, you’ll be able to handle it – without being forced into taking on any debt.
How much money should be in an Emergency Fund?
There is no hard and fast rule about how much money you should have in your emergency fund, but most financial planners will advise at least 3-6 months of expenses.
If you are in a two-income household and have been in a stable job for more than a few years, a three-month emergency fund is probably going to be sufficient.
However, if you are a solo earner, you work on commission, are self-employed, or you have other factors in your life that could lead to instability, you should instead focus on accumulating an emergency fund of at least six months. Illness, job loss, or other crises could lead to an inability to pay your bills, rent, and living expenses.
In a nutshell, the more riskier your situation or unstable your income, the bigger your fund should be.
Of course, if you really want to play it safe, build up as much of an emergency fund as you can afford to. I know some people who have at least 12-24 months’ worth of expenses put away!
What if I have debts?
If you have any consumer debt (such as credit cards or personal loans), you’ll need to strike a balance between clearing that debt and building an emergency fund.
My advice is to work on building a starter emergency fund of at least £1000. Once you have this basic emergency fund set aside, you should then work hard at chipping away at your debt.
The debt snowball is a good way to get this done.
Once you are out of consumer debt, you can get started on adding to your emergency fund until you have at least three to six months of household expenses in a savings account.
What kind of an account should I use for my Emergency Fund?
Your emergency fund should be in cash, in a high interest, easy access account. The nature of emergencies means – in the case of one – you will need to access your money quickly.
An account where your money is locked away for a year or two is no good. And neither is the stock market – even if your head is turned by the potentially higher returns.
I like the easily accessible, yet high interest account offered by Goldman Sachs – their Marcus online savings account. It’s an online only account, which offers one of the highest interest rates on the market.
Rates can change quite frequently though, so check out comparison sites such as PocketRate, where you can compare rates and account features.
Another option for your emergency fund, is to put it in premium bonds. The interest rate is much lower than the Marcus account, but there is always the chance you could win £25 (or perhaps the cool 1 million!) tax-free, which will beat the interest rate on any bank savings account. This isn’t guaranteed though, so your money could end up earning 0%.
I would also recommend keeping the money in an account that is totally separate from your main day-to-day banking accounts. You need to resist the temptation to dip into it when you want a nice meal out or a cheeky mini-break!
Remember too that the purpose of your emergency fund is to dig you out of a hole when you need it most – NOT to earn you a great return. That’s not what these accounts are for.
When is it a good time to use my emergency fund?
We have listed some of the times it is necessary to use an emergency fund above – such as when the car breaks down, the dog needs an operation or an unexpected loss of income.
However, with some sudden expenses, it can be hard to know if it is the right time to withdraw money from this account.
When you’re not sure if you should use your emergency fund, try asking yourself the following three questions:
- Is this expense truly unexpected?
- Is this expense necessary and unavoidable?
- Is this expense urgent and time sensitive?
If you can answer yes to these questions, you can use your emergency fund without hesitation. However, if you find yourself answering ‘no,’ or you have to really think about the answers, you might want to reconsider. Try to find another way to manage the situation so that you can maintain your emergency fund for the real emergencies.
A 3-step plan for building your Emergency Fund
We all have our own preferred ways to save money, and some of them are far more effective than others. Take the steps below and tweak them to suit your own personal style and needs.
1. Create a budget
Creating a budget can be done in countless different ways. But all of them require you to tally up your monthly income and outgoings. Once you do this, you’ll know how much you can save each month. Set aside your savings first and treat them like they are a vital bill that must be paid every month.
2. Determine your monthly savings goal
Some people like to set a daily, weekly, or monthly savings goal – but the most important factor is that you continue to add money to your emergency fund. If you stay dedicated to your goal and start adding any extra money you can, your emergency fund will grow quicker than you think.
3. Add more to your savings as time goes by
As time passes, you might be able to start saving more and more. If you get a raise, you can add that percentage to your fund. You can also look for new ways to save money, such as using apps that round up your spending and deposit the money into your savings account too.
Or have a think about other ways you can increase your income through side hustles, and put that money into your emergency fund.
Imagine what it would be like to have a financial buffer
Really take a moment to close your eyes and imagine a financial safety net there to help protect you in your time of need.
A six-month emergency fund can help you to truly relax in the knowledge that you and your family will be taken care of, in case of an emergency or unforeseen circumstance.
Think of it as an insurance policy
Think of your emergency fund as an insurance policy that you pay into on a monthly basis. Yes, it costs money and takes some planning, sacrifice, and patience, but it will pay off when you have no other options.
You can breathe a sigh of relief when your car breaks down, you lose a freelance client, or you have an unexpected illness that forces you to take time off work.
As the world struggles to deal with the calamity of COVID-19, can you truly put a price on the peace of mind and security an emergency fund could buy you?