Today, I am going to share 2 tips to build an emergency fund, but why?
An emergency fund, sometimes called a sinking fund is a pot of money set aside for an emergency. An emergency could include a loss of income, boiler repair and or replacing or repairing a car.
More than 16 million people in the UK have less than £100 in savings and 27% of the population have no savings at all. It’s one of the underlying factors behind the increase in household debt. Debt can be overwhelming and this is exacerbated when we don’t have a financial safety net. It leads to money worries, which in turn is a contributing factor to stress anxiety and poor mental health.
Now, admittedly this sounds depressing and you would be right but the reality is we will all have financial emergencies. It’s a matter of when not if and to make things worse we won’t be able to tell how this emergency will come about.
So how do we build an emergency fund, how much do we need and where do we put it? These are common questions I’m sure are at the forefront of your mind.
How much do you need in an emergency fund?
There isn’t a scientific answer to this, in fact, an emergency fund can vary for different people. It really depends on your personal circumstances and what you feel comfortable with.
As a financial adviser, when I was working with clients we would aim for a minimum of six months as a rule. An emergency fund should cover your essential expenses. Six months is generally viewed as sufficient time to find alternative employment in the case of redundancy and enough time to recover from most medical layoffs.
Take a minute to work out what six months expenses is for you. Remember, this will be your essential expenditure only. For example, rent or mortgage, utility bills, credit cards, car finance and so on.
Now that you’ve given it a thought, you may be staring at a big number. For many, six months expenses may be frightening but it’s the safety net you need to maintain your lifestyle should the worse happen.
So, what are my 2 tips to build an emergency fund?
- A BIG GOAL IS A SERIES OF SMALLER GOALS.
Now that you have a number in mind, you must view it pragmatically. Whatever number you identified, I recommend breaking it down into smaller bite-sized amounts. I call this road mapping.
Road-mapping will help plot a course to your final destination, six months expenses. For example, if your number is £12,000, you should set a target for a one-month emergency fund and work your way up progressively. When you do this, it’s crucial to put a time limit to this for your own accountability. Remember when setting any goal it has to be SMART – Specific, Measurable, Achievable, Relevant and Timely.
Automation has worked a treat for me personally. It takes away the doubt and hesitation we often feel. It takes it off our to-do list and helps form that savings habit.
Set up a monthly standing order to a separate account where this fund will be held. Try to do this as close to your payday as possible. It might feel strange to begin but it will soon become second nature.
Where to put this money
Think tax efficiency first. It’s the first rule of financial planning and a great place to start. An ISA is an ideal candidate for the job, however, a cash ISA would be best. Remember, your emergency fund needs to be accessible in cases of an emergency. A cash ISA will provide a tax-free and access environment. With an annual tax allowance of £20,000 every tax year (April 6 – April 5) it’s a great home for an emergency fund.
When accumulating your emergency fund please consider how you will keep yourself accountable to the purpose of the fund. If you are likely to access the money at a whim, I would suggest an account with ATM card or a short notice account (charges may apply if you access a notice account without giving notice). If you are unlikely to access the money, an instant access account should suffice.
Those are my 2 tips to build an emergency fund, to watch a video on this topic click here
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For my guide on how to build an emergency fund click here