Understanding the Importance of an Emergency Fund

Life can throw you curveballs at any time and being as prepared as possible is important. An emergency fund is the cash you have immediately available, should you have a sudden unexpected cost.

Types of Emergencies and Their Financial Impact

Emergencies can come in several different scenarios:

  • Home or car repairs/replacement
  • Sudden medical issues that require private treatment
  • Redundancy or job loss

These circumstances may not solely affect you but could also impact your partner, children or close family members who rely on you financially.

Determining Your Emergency Fund Needs

For each person, ‘how much is enough’ can be very different, but we like to establish a general rule of thumb to get started when thinking about what is needed.

Stage 1: Work Out Your Essential Monthly Spending

Should you suddenly have a change in circumstances you can potentially adjust your budget and reduce spending, but you will still have bills to pay to keep your house warm and food on the table. You need to cover these as your priority.

Stage 2: Building the Emergency Fund

Working age and not yet retired: 3 to 6 months of living or committed expenses.

3 months should be the bare minimum and 6 months is the ideal scenario to support your ability to cover the unexpected.

If your circumstances are more complex or ‘risky’ then you may wish to save more to provide a longer period of protection. So, if you are self-employed or work in an industry that has a high turnover/unemployment then a bigger pot to protect would be useful.

Retired and no longer working: 12 months of committed spending (after guaranteed income).

In retirement you may not have as much income as you did whilst working, but some of this may be guaranteed. You may have State Pension, Company Pension or an annuity in payment. We would highlight having the difference between your annual spending and the guaranteed income you have over 12 months as your emergency pot.

This should give you flexibility to continue to live your life whilst you adjust your long-term planning if anything unexpected should suddenly hit.

Tailoring Your Emergency Fund to Your Life Stage

Planning for Large Capital Spending: Any big plans within 5 years. Should you have any plans to spend money on one off expenditure (like a new car, property renovation or a one-off holiday) within the next 5 years then this should be saved and retained in cash. This will provide the certainty of having the capital to meet these planned needs rather than risking the funds won’t be there when you need them.

Supplementing Your Emergency Fund with Insurance to provide yourself with some support is insurance. You can protect against health cost issues (Private Medical Insurance) or unexpected house costs (comprehensive Home Insurance) for example.

Avoiding Debt:

Ideally, you would not want to use credit cards or debt as a way to get yourself out of trouble, as it may not help in the long term.

Assessing Your Comfort Level: One Size Doesn’t Fit All

Some people are fine having less in their ‘just in case’ pot than others so it must be what makes you feel comfortable. The important thing is to save what you can, even if it is less than you think you need, as you have something to call upon.

Taking Action: Starting Your Emergency Fund Journey

Work out what your figure is and start working towards this first. Once you have this in place then you can think about what to do if you have more than this in cash!

More info on https://www.moneyhelper.org.uk

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