In the first article in this series we looked at how important it is to have an emergency fund, no matter how small it might be (unless you’re struggling with high interest debts and can still get a line of credit).
Now let’s run through the basics of setting up an emergency fund. There’s some conflicting advice about this, but there is a lot of general mumbo jumbo and woo woo about personal finance – and especially about emergency funds – around at the moment. This is the straightforward, no-nonsense approach. Just the maths, Ma’am (or Sir).
Choosing the right account
First of all, an emergency fund needs to be ultra easy to access during an emergency. This might sound a bit obvious but I saw a completely moronic article yesterday suggesting that you should keep your emergency fund invested in the stock market, which might be one of the daftest pieces of advice I’ve seen in a long, long time. You could lose a lot of money doing that, in fact you could lose the whole lot.
You need ‘liquidity’ for an emergency fund, which means cash savings only. They should be instant access, so don’t put them in a term or notice account.
Most people will also need to keep their emergency fund money separate from their other money. For example, while I’m fairly organised with my finances, there’s no way I can manage keeping my emergency fund in my current account along with my everyday finances – it would be far too easy to accidentally spend it…and possibly a little too tempting to have in my line of sight as well.
My emergency fund is currently being saved into a market-leading-rate cash ISA with instant access. This might change after the new tax year starts because tax on savings will be changing (I’ll write more about that another time) and non-ISA cash savings accounts might become more appealing. At the moment, the interest rate is good and the ISA wrapper means the taxman doesn’t get hold of any of the interest paid on the savings.
Getting a good rate of interest on your savings
Anyway, the important thing to remember is that you need to ensure you have a good rate of interest on your saved money, as well as easy access to it. If the rate is too low, your savings can become eroded by inflation and in real terms they’ll lose some of their spending power – which is definitely not what you want if you ever need to use the cash.
Shop around, and don’t take the first savings or cash ISA account that comes up. There are various price comparison sites out there, so browse through two or three of those to see the current market and what’s available.
Check the terms & conditions of the account carefully:
· Is it truly instant access, or do you have to wait to get at the money?
· Do you lose interest for a period of time if you withdraw funds?
· Is there a penalty of some sort for making two or more withdrawals in a year or other set time period?
· Do you have to commit to paying a minimum amount in each month? (that might be tricky in a financial emergency)
You have to weigh any inconveniences against the interest rate. For example, my cash ISA drops to a lower interest rate if I withdraw funds more than four times in a 12-month period. As I’m keeping this particular savings pot only for true emergencies, I’m fairly confident I won’t be having five or more of those in a given year.
How to fill your emergency fund
If you have a lump sum of cash hanging around, you can split some of that off into a cash savings account. Most people don’t have that luxury, of course, and will have to start saving up. It’s up to you whether you save steadily, or whether you make a temporary sacrifice to get some more funds stashed away quickly. For example, some people like to cut back hard on their expenditure for a couple of months, say, so they can put £500 or more into their emergency fund and have peace of mind sooner.
Going extra heavy on the budgeting for a month or two is relatively short term, and isn’t that much of a hardship psychologically because the end is clearly in sight and there’s a defined goal. There’s also an obvious long-term benefit of greater financial resilience and security.
Many people won’t be in a position to get a small lump sum together at the start, due to income levels and financial commitments. If that applies you you, it may still be possible to re-draw your monthly budget to create a regular sum of money to put towards your emergency fund savings. The easiest way to do this is by setting up a standing order that comes out of your account shortly after payday, for whatever amount that you can comfortably afford. Any amount is good – even if it’s only a few pounds, something is always better than nothing and it will build up over time.
Some current accounts also let you set up a ‘sweep’ at the end of each month or directly before payday. This puts any surplus into your savings for you automatically, and might be useful if you usually have a few pounds left over and don’t tend to get overdrawn.
If you’re already budgeting well but you’re only breaking even, it might seem impossible to save. However there are still a few ways that you can start and pay into an emergency fund without surplus money in your budget, and we’ll be looking at that in the next article.
Are you thinking about putting some money aside for an emergency fund?