A number of recent surveys have suggested that we Brits have largely stopped saving for a rainy day. While part of this has undoubtedly been caused by wages not keeping up with the cost of living, and a range of benefits-related issues, many people who could technically afford to create an emergency fund simply aren’t doing so.
Emergency savings were traditionally seen as a must have, in addition to longer-term savings or nest eggs. They were regarded as part and parcel of being a responsible, independent adult. It wasn’t looked down upon as old fashioned, or stuffy or boring, it was just something you did to look after you and yours.
There seems to have been a shift in attitude and we’re collectively spending our money on other things, and if something bad happened then many of us would turn to credit to cover a shortfall instead. However, it’s a classic example of short-term thinking that can cost you dearly in the long run, and if you’re already carrying a fair amount of consumer debt then it’s easy to find yourself overextended and in a hole that’s increasingly difficult to climb out of.
If you don’t have an emergency fund, and you’re fairly free from non-mortgage debts, consider this lack of savings as an emergency situation in your personal finances. Prioritise the creation of one and put your back into it.
What is an emergency fund for, exactly?
The two main real emergencies are being unable to work due to injury or illness, or losing your job. Job security isn’t great at the moment. Zero hour contracts are still rife. Redundancies are still happening. Complaints about bullying and unfair dismissals are on the rise… Worried yet?
Other potential emergencies include:
- Extreme and unpredictable price hikes in bills (which happened to 2 million people in the UK in the last 12 months)
- Having to leave a partner in a hurry
- Problems with landlords such as illegal evictions or theft of deposit
- Broken down home appliances not covered by insurance
- Cars needing expensive repairs not covered by insurance
Emergencies aren’t predictable, they can happen at any time. You don’t see them coming. There’s no brace position once they’ve started.
Having an emergency fund in place is a short term safety net. You could even consider it a way of ‘insuring’ yourself in the short term (although you should also be looking at proper insurance that’s suitable for your personal circumstances, whether that’s critical illness cover, mortgage protection, or whatever else you might need).
How much do I need for my emergency fund?
The typical advice about emergency funds is that you need to save up three to six months of outgoings in an easy access cash savings account. That means basic outgoings, in other words only the essentials, rather than your everyday random spending with a few treats thrown in. It should include rent/mortgage, utility bills, basic groceries, insurance payments, etc. It’s about keeping a roof over your head and making sure payments and repayments aren’t missed so you don’t get into trouble with creditors.
It’s supposed to give you breathing space and a little stress relief while you search for a new job, recover from illness or injury, or (worst case scenario) wait for the heavy duty insurance to kick in. A lot of insurance and other financial protection takes about three months to be paid so you need to have money to fall back on while you’re waiting.
If you’re a standard employee then three months of basic outgoings should be an okay amount, unless you work in an industry where it’s really difficult to find new employment. If you’re a freelancer or work in an industry where work is unpredictable or payments are irregular, you need a bigger fund – in an ideal world.
I say an ideal world, because it’s easy to look at that amount of money, feel utterly overwhelmed and go into a total panic. From there, it’s easy to have all or nothing thinking…and put nothing away at all.
The truth is that something is always better than nothing when it comes to emergency funds (unless you have serious debts, but more about that in a minute). If all you can afford to save is £1 a week, or some spare change in a jar, do it! A slimline emergency fund for £500 or £1,000 is still helpful, so if you’re just starting out then you could set that as your first savings target. You can always beef it up later.
Make your emergency savings easy to get to, ideally with a good rate of interest being paid on them so they aren’t eroded by inflation, and be ultra disciplined about not dipping into them for non-emergency spending.
A holiday, a random bargain or a new pair of shoes is NOT an emergency, however much some of us like to kid ourselves (operative word ‘kid’, we’re adulting here), so create separate savings for those sorts of things and make sure they don’t get mixed up. Likewise, Christmas, birthdays, standard bills and household maintenance are predictable expenses that should come out of your regular budgeting, not your emergency savings.
When shouldn’t you make an emergency fund?
It’s not appropriate to create an emergency fund if you have a large amount of non-mortgage debts, especially high interest ones. The amount you pay out in debt interest is always going to be much higher than the amount you’ll receive in interest on your savings – so it’s smarter to use any cash savings to pay off debts.
While it’s tempting to hang on to the psychological security blanket of savings in the face of debt, please believe me when I say that a high interest debt such as an unpaid payday loan is far more of a real immediate emergency than a theoretical future emergency. Think calmly, put emotion to one side and let maths come to the rescue – reduce your debt load instead. If you insist on keeping some savings back, cap it at a few hundred pounds and remember to consider those long term costs.
Do you have an emergency fund already? If not, are you thinking about starting one?