Building an Emergency Fund When money is tight, the last thing that many people can think about is squirreling cash away for a rainy day, month or year.
With home energy bills, food costs, and prices at the pump, among others, all rising, saving is becoming harder than ever.
But that means it’s even more important to try and create an emergency fund. Here’s why and how to begin:
What is an emergency fund? An emergency fund is 3-6 months of essential bills and living costs. This typically rises to 6-12 months for sole earners in a multi-person household or those who are self-employed. It is not a replacement of an entire salary, but rather a plan to ensure core living costs are covered if a key source of income suddenly disappears. This helps avoid having to borrow money via credit cards, overdrafts, or loans. This will hopefully give you breathing space to find a new source of income without having to worry about getting into expensive debt.
When might I need to use my emergency fund? Emergency funds are typically very useful if a main or major source of income suddenly stops. This could be due to:
Having to look after a relative
Paying for unexpected legal action
During these stressful events, the main aim is to make sure you’re protected from crucial debts that month-to-month income would otherwise have covered, such as your mortgage, rent, council tax, energy and food bills.
When should I start an emergency fund?
While we recommend starting an emergency fund as soon as possible, we know it’s simply not possible for everyone to save up 3 months worth of bills overnight. However, any money you may be able to save into your fund will help in times of financial crisis. Perhaps start with a goal of £500 and gradually add what you can at the end of each month.
The best time to start an emergency fund if you don’t already to have one is now, if you are able to.
What is an emergency fund not?
An emergency fund is not the same pot that you may dip into for holidays, Christmas or for luxuries. These should be paid for from other savings or income. While we all need a break now and again, the emergency fund is there for times when debt would otherwise be the only option.
Where should I keep the money?
Emergency funds need to be easily accessible and reliable. Therefore, there is little point keeping them in any account rather than an easy access (not fixed) savings account. Interest rates are still pitifully low, but at least the cash is safe up to £85,000 per account. Check out Moneysaving Expert for account ideas.
Do not keep the money in ISAs, the stock market, crypto currency or other volatile or slow-to-access investments. Think, “If I needed this money tomorrow could I get hold of it?”
Paying Off Debt vs Emergency Funds
A real conundrum is if you have debt such as credit cards that you are trying to pay down with cash that you are thinking of putting into an emergency fund. It’s very unlikely that any of the easy access accounts will pay more interest than you’re being charged on your consumer debt obligations.
The questions is, should I pay off my credit card or build my own pot? In general, it is better to pay off the debt as overall you will end up with more cash. If you have access to a credit card that could help in an emergency if you don’t have a fund, then you could always use that if the worst does happen. It’s not ideal, but at least you won’t be losing more money than necessary on interest to the card provider each month.
This really is up to each individual, depending on how comfortable they are with the amount of savings they require and the type of payments an emergency fund would be used to cover. For example, you won’t usually be able to pay off your mortgage with a credit card, this would need to be done in the normal way via your bank account.
How can I start an emergency fund? Even if you can’t spare a penny from your monthly budget, look at your current outgoings. Take a moment to go over all your Standing Orders and Direct Debits on both your bank accounts and credit cards. It’s not a good idea to cancel either of these without first discussing with the companies they are set up with, as those companies may pursue you for the payment (e.g., mortgage or credit card firms). However, Brits lose hundreds of millions of pounds a year for regular payments that they simply do not use (see our article about unused subscriptions, here).
A straightforward way to manage free trials and unused subscriptions is to download the free Little Birdie app. We will look after pesky regular payments that you no longer want or need and offer to switch you to better deals if you are keen. You could then put this money towards starting your fund. We hope you’ll never need it, but if you do, you will have the peace of mind that it’s there.
Please note, this article is the opinion of Little Birdie staff and does not constitute financial advice.