Life is inherently unpredictable. From little things like replacing washing machine or fridge, unexpected car/home repair bills to sudden job lossesđ¸, unforeseen circumstances can disrupt even the most meticulously planned financial trajectory. This is where the concept of an emergency fund emerges as a backbone of financial security, your first line of defence đ§ą.
Why
At its core, an emergency fund is essentially a safety net, a pool of readily accessible cash reserved for those inevitable life curveballs. It is part of the 'Sleep Well' money, the money safety-net to allow you to be sound asleep at nightđ´. Knowing that whatever tomorrow or next week happens, you can respond with money firepower to make sure immediate issues are taken care of first. Instead of panicking or making hasty decisions, you can calmlyđ assess the situation and make informed choices.
This financial cushion provides a buffer against financial hardship, preventing individuals from resorting to high-interest debt or depleting long-term savings and investments. There is no point in anchoringâď¸ all your money in the most perfect investment vechicles and having to quickly sellout just because of an ill-timed bill you did not predict you needed the cash for. Not just losing on the opportunity cost of the future growth of those investment vechicles, but also losing out of the transaction fees you paid twice when buying initially AND selling the investments back to cash.
Moreover, an emergency fund can prevent you from accumulating high-interest debt. When confronted with unexpected expenses, individuals without a safety net often turn to credit cards or personal loans. These options, while tempting in the moment, can lead to a cycle of high interest debt that is notoriously difficult to escape.
Amount
The ideal amount for an emergency fund varies depending on individual circumstances, such as income, expenses, and dependents in your householdđ¨âđŠâđ§âđŚ. Financial experts often recommend aiming for three to six months' worth of living expenses. You need the amount to be big enough to cover for several months of loss of income. However, you wouldn't want the emergency fund to be the majority of your savings, as you are ultimately losing out on the potential growth via investmentsâŤď¸ and keeping ALL your money in cash is eventually a losing game due to another money enemy called inflation. I will write another blog post about inflation.
It is essential to remember that an emergency fund is not a static concept. As your financial situation changes, so too should the size of your emergency fund. Life events such as marriage, childbirth, or homeownership may necessitate adjustments to your savings goals. Regular reviews of your budget đ¤and financial goals will help ensure that your emergency fund remains adequate. It is also wrong to presume emergency fund is only for people with family unit or children. Single individuals đŠ should also have this emergency fund ready, in fact I would argue that single individuals need this as well as there is no income from partners to buffer when unexpected hard times arrive.
Different people will have different emergency fund amounts. It's not just because of the difference in life circumstances, but also everyone will have different risk and investment appetites. I will be writing a seperate post showing you my own emergency post. Some will find it too cautious, some will find it too risky. Enough to say, it is the right amount for me now at this point in my life. It is enough to allow me to sleep well and to not dip into any debt or high interest loans. I adjust it as time goes by. The amount 5 years ago was different from now, as my siutation has changed.
Contractual sick payđ¤˘
It is important to read up on your contract regarding sick pay from your employer. On the NHS, most staff is entitled to full pay for a few weeks, then half pay for a longer period after. You may also be entitled to Statutory Sick Pay (SSP) from the government as well. SSP amount is approximately ÂŁ116/week for approximately 28 weeks. So when you are calculating your emergency fund, you may take into account this small pot of money to adjust how much you need to save up for in the event of an illnessđ¤Ž. This does alter my amount planned for an emergency fund, I will explain in the post later about my emergency fund.
Psychology
Beyond its role in crisis management, an emergency fund can also serve as a catalyst for other financial goalsđĽ . I started my saving practice by building the emergency fund. Once you experienced saving for an emergency fund, you are better positioned to save for larger purchases, such as a home đ or a carđ. It also provides a foundation for investing, as you can allocate future savings to growth-oriented investments without fear of depleting your savings. This is not just for practical reasons, it is also your money psychology in your head đ¤Żwe are managing. Once you are used to seeing a safe pot of money, you start to generate good money practices. Once you have your emergency fund, your wealth foundationđ has been laid down.
How
Building an emergency fund may seem daunting, especially for those with limited income. However, even small, consistent contributions can make a significant difference over time. Automating savings is an effective strategy, as it ensures that money is automatically transferred from your checking account to a savings account on a regular basis. Essentially its part of the 'Pay Yourself First' habit, just like for debt management and investing habits in the future. It comes out before your luxury spending.
Remember, personal finance is not rocket science, the maths involved should be as easy as 'back-of-the-napkin' or 'do-it-in-your-head' đââď¸quick maths. Keep it simple and easy for yourself. Also this is not a fixed decision, it's fluid, it's dynamic. If you make a plan, make sure you understand you can change and improve the plan as your finances become more clear to you. IF you really are tight with money at the moment, start with tiny amounts, even as low as ÂŁ25-50 per week! Thats approximately ÂŁ100 a month. In 6 months, thats ÂŁ600 in a safe-haven account. If you can afford higher, start with ÂŁ200 per monthly salary; in 6 months, that's ÂŁ1200 saved up. Start small, and start building it up every few months.
Habit
When I started building my emergency fund, I basically set up an automatic transfer the day after my pay check comes out into a seperate savings or cash ISA account. (I will touch on what a cash ISA is soon on a seperate blog post). It doesnt matter how small of an amount you set aside each month for this fund, remember, the sooner you fill up your emergency fund pot, the sooner you get to build your investment wealth.
You have to be strict on yourselfđ¤¨đ§, the emergency fund is for EMERGENCY ONLY. Not for doing the xmas shopping or paying for a holiday. No excuses. If you need cash for those, seperately slowly save up for it somewhere else. Be tough to be kind to yourself. If I had to dip into the emergency fund, when next month's pay comes, I will replenish that emergency fund to the previously decided amount, before using spare cash for investing or luxury spending. If there is a hole in the emergency fundđł, fill that hole before you use money for other activity.
We will be talking about budgeting shortly and how to cut down on pointless monthly spendings, you will be able to rack up those monthly savings quicker than you think.
Accounts
Here are some common places to build one:
Higher interest savings accounts: These offer a bit of a return while keeping your money accessible.
Cash ISAs: Tax-free savings accounts can be a good option. I.e. you are not taxed on the interest earnings in that account.
Building society accounts: These often provide competitive rates and easy access.
Important Considerations
Accessibility: Ensure your chosen fund allows easy quick withdrawalâĄď¸ without penalties. Beware that some accounts even take a while before they let you have access to the money after notification of withdrawal. So always check, emergency fund needs emergency access. Pick accounts that you can withdraw quickly within 24-hour notice. It's basically digital cash.
Interest rates: Aim for a slightly higher than usual interest rate if you can. But don't get too fixated on the interest rate, remember, this will soon be a smaller pot of your wealth. Your investments will soon do all the growing for you. The emergency fund is cash in hand for safety. Interest growth is not your main concern here.
Additionally, due to the harsh economic climate, some employers even offer emergency saving options as part of their employer-sponsored retirement plans. However, The NHS pension scheme itself doesn't directly offer emergency fund options.
In conclusion, an emergency fund is a vital component of financial well-being. It provides a safety net against unforeseen circumstances, protects against high-interest debt, and creates a foundation for achieving other financial objectives. Building your emergency fund will also improve your saving and budgeting psychology. I think of it like the warm-up before the real race. Once you know how to build an emergency fund, you will get the hang of building an investment pot of money etc.
While building an emergency fund may require discipline and sacrifice, the peace of mind and financial security it offers are invaluable. By prioritising emergency savings, individuals can take a proactive approach to managing their finances and building a stronger financial future
Learning points - Emergency fund | |
|---|---|
Nature | For emergency only |
Why | Sleep-Well money as a finanical security foundation For events that are unpredictable |
When | Now Set up and ready before investments and luxury spending Can be paying down debt too whilst setting up |
Amount | 3 to 6 months of essential living expenses Take into account your contractual sick pay Depends on your risk tolerance, household dependents and financial needs |
Where | Cash account with quick access and no withdrawl penalties |
**DISCLAIMER**
All content provided on this platform is intended for informational, educational and entertainment purposes only, and should not be construed as strict financial advice. The information presented does not constitute a recommendation to buy or sell any specific security, investment product, or service. Investing involves risk, including the potential loss of principal (money). It is important to conduct thorough research or consult with a qualified financial advisor before making any investment decisions.
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