The state of savings
In the UK 46% of people have less than £1000 in savings with 25% of the population having £200 or less according to Finder. Although having some money saved is better than nothing a single incident could wipe out these savings and put you in a very uncomfortable financial situation. I believe everyone should be working towards a minimum level of financial security which is where the emergency fund comes in.
What is an emergency fund?
An emergency fund is a pot of savings stashed away for all life’s emergencies. It means when something unexpected happens you don’t have to worry about where the money will come from and you can just focus on dealing with the issue at hand.
Why is it a priority?
When you start saving money an emergency fund should be top of the list. Not only does it act as insurance against any unexpected situations but it also gives you peace of mind knowing that no matter the issue you’ll have a way to pay for it. No one can know what the future holds but you can say for certain that something will surprise you and it usually happens exactly when you don’t want it too.
Recommended Reading: Learn how to create the perfect budget for you with Budgeting For Beginners.
The general guidance
There is no one size fits all advice for the size of your emergency fund but this is the general guidance I follow to help get the most out of an emergency fund.
- 3-6 months of your essential living costs.
- Where you land in this range depends upon your personal situation. Some thoughts to consider include your appetite for risk, how stable your job is, your overall financial situation and if you have others relying on your income.
- Essential living costs are your monthly bills for accommodation, utilities, groceries, transport and potentially any high interest debt repayments. This is not your monthly salary so it is more achievable than you think.
- If you use your emergency fund try to replace it as soon as you are capable.
- Only use this for emergencies! Setting a list of spending rules can help prevent unnecessary spending.
- Keep it in an instant access cash savings account with no limits on withdrawals to ensure the money is there when you need it.
- Don’t worry too much about the interest rate of your account. This money is not there to generate wealth however ensure you’re getting the average market rate to help reduce the impact of inflation.
- Reassess your target amount yearly or whenever your financial situation changes.
How I built up an emergency fund from scratch
At the start of my new job 1 year ago money was tight. I’d had to buy a car for commuting and this along with the associated costs of insurance and road tax had wiped out my savings and emergency fund. This meant I would be starting from scratch to build up my emergency fund again.
Creating my target goal
For my emergency fund my target amount was for the low end of around 2-3 months. I am lucky to have no one relying on my income and I have fairly low essential costs with minimal debt. I am currently in a stable job position meaning I am more than comfortable in having a fairly low emergency fund buffer.
In order to create this pot of money I first had to get my target figure. From my budgeting I knew that my essential costs were a touch over £1000 making £3000 my initial goal. I knew I wanted to have this together within 12 months which meant roughly around £250 per month. However I didn’t want this to disrupt my monthly payments into investments through my Stocks and Shares ISA. With this in mind the most I could comfortable put away into an emergency fund was £200 a month.
At £200 a month this would result in £2400 saved over a year giving me nearly a 2.5 month emergency buffer. This I felt very comfortable with as I would be 80% of the way to £3000 within a year.
Why I chose to prioritise my investments
As I am in my mid 20’s I have time on my side and I want to benefit from compounding in the long term through my investments. I had been slowly building up my investments for two years prior and had managed to avoid selling up when I needed to buy a car. I felt it would give me the best result if I continued to drip feed into both my investments and my emergency fund. This way I would keep up the momentum in my investing but also slowly build up a cash reserve to avoid having to sell my investments in an emergency. This was the best compromise for me based on my risks tolerance. This may not work for others but again it all comes down to personal preference.
How to save up your emergency fund
Now I knew I would be saving £200 a month I could figure out my strategy for saving. First of all I allocated £200 to savings in my monthly budget and ensured it was apart of my monthly payday ritual. This meant every pay day I would immediately set aside the £200 so I wouldn’t spend it.
Recommended Reading: Learn the power of creating your own Payday Ritual.
Next I had to decide where to put my money. As it was over a short term this immediately rules out investing as I couldn’t risk a drop in value. This meant a cash vehicle such as a savings account would be the right call. At the time interest on savings accounts and Cash ISAs were high around 5%. This was an option but because I was saving this monthly there were other choices. In the end I chose to open a regular savings account. These accounts usually have a higher interest rate fixed for a year however there is an initial and monthly deposit limit. In my case Nationwide had opened an 8% regular saver which made it a no-brainer to open and utilise. It also had no withdrawal penalties meaning I could still use the money if an emergency occurred.
Interest
The interest for this account would be provided 12 months after the initial set up. By the end of the year I had saved up my £2400, avoided having to withdraw any of the money and was about to receive my interest. Now regular savers are interesting as their high interest rates are only for a fixed term (in this case 1 year) and they have deposit limits. For me this meant only the first deposit actually benefits from the full year at the interest advertised. Using £2400 as an example you can see the difference between 8% on a lump sum and 8% through monthly saving.
Total Saved |
Savings Method |
Interest |
Interest Gained |
Total |
Equivalent Interest |
|---|---|---|---|---|---|
£2400
|
£200 per month
|
8%
|
£103
|
£2503
|
4.3%
|
£2400
|
Lump Sum Upon Opening
|
8%
|
£192
|
£2592
|
8%
|
As you can see through the equivalent interest rate its roughly around half the interest percentage advertised. This is a good rule to know when understanding the returns you can get from these accounts. No matter if you’re creating an emergency fund through a lump sum, monthly saving or a combination, picking the right vehicle matters. By choosing a high interest savings account you can get to your target goal that little bit easier and quicker.
Recommended Reading: Use Money Saving Expert to find the best Regular Savings Accounts available in the UK.
Reaching my target
After getting my interest I was now over my 2.5 month target with only £500 to go to reach the 3 month total. I can happily say I have now reached this goal 15 months after setting out. In the mean time my investments which I still managed to invest in have also seen good growth which I potentially wouldn’t have benefitted from if I hadn’t been flexible with my goals.
Maintaining an emergency fund
Using your emergency fund
Don’t be afraid to use it in a genuine emergency. It can feel daunting using this money after spending such a long time accumulating it but remember, you’ve built it up for a reason!
After using your emergency fund always ensure you begin to replace this money as soon as you are capable. Having that buffer built up again will provide you greater peace of mind and security ahead of any future emergencies.
Where to keep your saved up fund
Now the fund is saved up instant access is a necessity. This means a high interest instant access saving account with no withdrawal limits is your best option. I have moved mine into an account like this currently and will continue to monitor interest rates in case a move to a different provider would create better returns. Obviously this money is a buffer and not meant to be generating wealth but minimising its decrease in value to inflation is always worth doing.
Recommended Reading: Use Money Saving Expert to find the best Savings Accounts available in the UK.
Your target will change with time
The target amount for your emergency fund will differ with time. Their may be increases to your bills, you may have to look after a sick relative or your job security may have changed. In these situation you may need to adjust your emergency fund targets. My plan going forward will be to assess my target figure yearly to ensure its keeping up with my essential costs and offering the security I need in my life. I’ll then rebudget if I feel the need to add more to the pot.
Conclusion
An emergency fund is an extremely important asset to have and as such is one of the top priorities for everyone. I hope this article highlighted this and showed a clear path to building one up for yourself. Have a great day and happy saving!
Disclaimer
All information is not financial advice and is purely meant for educational purposes only. Investing involves the risk of loss of capital as well as its gain. Any investments mentioned on this website are meant as examples not specific recommendations. Always do your own research and/or gain the help of a financial advisor.
