An emergency fund, also known as a ‘rainy day fund’, is money you set aside to use for unexpected events. This could be anything from needing a new fridge freezer, to suddenly losing your job or being unable to work due to illness. In this article, we’re exploring the importance of emergency funds, and looking at how much you should be setting aside ‘just in case’.
What is the importance of having an emergency fund?
When you have money set aside for emergencies, you are much less likely to experience financial difficulties, or have to borrow at a high interest rate to get you through an unexpected situation.
Knowing you have money available should you need it can also provide you peace of mind.
Making an allowance for an emergency fund is an important part of the overall financial planning process. When you are working out your financial roadmap towards achieving your life goals, it is important to set aside some money that you can access instantly should the need arise, rather than seeing it all tied up in investments and savings accounts that you cannot tap into.
An emergency fund is also important in retirement. If you rely on the income from your investments to fund your everyday life, then you may have experienced market fluctuations that have impacted your portfolio. In such cases, an emergency fund is helpful as it will allow you to access cash when the markets are not performing too well, allowing you to avoid selling assets unnecessarily.
How much emergency fund should I have set aside?
How much emergency fund should I have is a common question. The answer will depend on your individual circumstances, how much you spend day to day, and the types of emergencies you may face, as well as what insurance protection you already have in place.
For example, if you have a family, loans and a mortgage, you will likely need a larger emergency fund that a single, debt-free person with no children.
If you have insurance to cover certain losses or expenses, you can probably get away with a smaller emergency fund. For example, if you have pet insurance, dental insurance, home contents cover or an income protection policy, you may only need enough to tide you over until you can access these payments.
The general rule of thumb is that you should set aside at least three to six months’ worth of living expenses as an emergency fund. So for example, if your essential outgoings every month (mortgage, rent, utility bills and food for example) are £1,000, then your fund should be £3,000. This may seem like a lot to aim for when you first get started, especially if your surplus income isn’t high, but it should not put you off. Even if you can put something aside, it is better than nothing.
How to go about building an emergency fund?
A good way to build your emergency fund can be to set up a regular transfer from your current account to a separate savings account so that amount of money is accounted for each month.
Try timing the transfer so that it leaves your bank account just after you get paid.
If you feel you cannot afford to save anything, try closely monitoring your spending for one or two months. It may be there are areas where you can cut back, perhaps by reviewing your utility providers and switching to a cheaper tariff.
Always make sure that your emergency fund can be easily accessed. Use an instant access savings account or cash ISA, for example, rather than accounts that require a long notice period for withdrawals.
If you have debts, it may not be the right move to start an emergency fund until these are settled. Really, it depends on the types of debts you have. If you have a manageable, low-cost loan, for example, then the emergency fund could still be a good idea.
However, if you have expensive debts such as credit cards, overdrafts or payday loans, or there are outstanding mortgage arrears, then you may be better placed using any spare money you have to pay these off before you start setting aside money for emergencies.
Looking for financial planning advice? Talk to the specialists at PMW.
At Partridge Muir & Warren, we have been advising our clients for more than half a century, specialising in tailored, independent financial planning.
From financial planning for individuals, to financial planning for families and specialist retirement planning, we can help you with all aspects of financial planning, including advising you on the best way to build your emergency fund.
Why not get in touch with our friendly team and arrange your no-obligation complimentary consultation? We look forward to supporting you on your journey towards your financial and life goals.