Emergency Fund: A financial 'cheque' up.
The pandemic showed that nothing is certain in life and that I was in need of a financial back-up, an emergency fund.
After sorting my budget to deal with my general expenses I knew that the next item on my agenda was to build an emergency fund; for everyday items such as the washing machine breaking down but also in case of a larger future emergency such as another global pandemic! Covid showed that nothing is certain in life and if I hadn't been so lucky with my job I would have needed a backup plan which had been lacking. I needed an emergency fund.
Why have an emergency fund?
Now I know that I mentioned that I had debts so shouldn't I have been paying them off first? Well, the answer probably depends on your circumstances. Having not been a good saver previously I decided I needed an initial cushion whilst making sure I made at least minimum payments to debt. I know that in the US they recommend three to six months of living expenses for an emergency fund while some financial experts in the UK have recommended 10% of your yearly salary.
Initially, I decided that three months of living expenses would suffice but this isn't right for everyone and any emergency fund no matter how small is better than nothing. In the UK our healthcare system may not be perfect but we don't need to worry about medical expenses thanks to the NHS and I am lucky enough to work in an industry where the demand for staff outstrips supply so finding a new job if required shouldn't be too hard. I also had a clear plan and budget that could be trimmed if a pay cut was required. Once the debt was paid off I could then look to increase the fund as part of my overall saving and investing goal.
What emergencies could occur?
The following issues highlight what could happen unexpectedly and affect our financial freedom if there are insufficient funds to cover them.
- Job loss: Economic downturns and pandemics can lead to unemployment. The pandemic caused bigger issues in the hospitality sector where it wasn't possible to get a new job if an entire industry shut down. Depending on the risk involved with your job it may be best to have more than three to six months of living expenses saved.
- Medical or dental emergency: Although we are lucky to have the NHS resources have been stretched which could lead to long wait times. If you do not have private medical insurance a savings buffer could be utilised to help pay for treatments.
- Home repairs: As highlighted before there is the potential for items to break down such as a washing machine but leaks, fires or structural damage could happen and insurance may not cover the cost of repair.
- Car repairs: The rising cost of cars on the secondhand market may lead to people keeping their existing cars for longer. A sudden bill for new tyres, clutch, head gasket etc could stretch your finances.
Isn't that what a credit card is for?
Credit cards can be handy to help cover a short-term bill, especially if it has a 0% interest rate. However, if you cannot afford to keep up with the repayments it will affect your credit rating in the future. Payday loans can also seem like an easy win to obtain money for covering an emergency but interest rates are often high and require re-payment when your next pay cheque lands. Having a savings buffer will prevent getting into further debt and there is even the chance to make a small amount of interest.
Where to save.
An emergency fund should be accessible enough to get easy access to but not so easy that it gets dipped into. I already had a Hargreaves Lansdown account for a Stocks and Shares ISA so I decided to use their Active Savings account for the emergency fund. This gave me the choice of various savings account types which could be accessed easily; but not as easily as a savings account attached to my regular banking accounts. The interest on these accounts was also slightly higher than the interest paid on standard high-street bank accounts. So far this seems to be paying off as I don't access my Hargreaves Lansdown account as regularly as a normal bank account but I still know my savings are there if I need them. You could also use a standard cash ISA or something like a savings space if you have a Starling account (or similar) though this may be too easy to access.
Conclusion.
Finally, after a few months of setting some of my salary aside, I had an initial month of living expenses saved that I could build upon and it was on to the next part of my plan; getting rid of my bad debt through good habits. What would be the best approach though - the avalanche or snowball method?
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