You never know when your boiler will break down or your car will need a major repair. It is important to have money set aside to cover these large one-off costs. This is where having some money set aside in an emergency fund is important. So if you are thinking of building up some emergency funds how much do you need to have?
Table of Contents
- What are emergency funds?
- How much of an emergency fund do I need?
- Where to save my emergency fund?
- How to start building your emergency fund
- What to do once you have built your emergency fund
- Are there any alternatives to emergency funds?
What are emergency funds?
None of us know what tomorrow will bring. We may win the lottery, we may fall in love or we may need money to pay for an unexpected bill. These unexpected expenses include everything from roof repairs to having to pay rent or mortgage payments if we unexpectedly lose our jobs.
Emergency funds are money that you have specifically set aside to cover any unexpected expenses. These are best kept separate from your other savings that you use to cover regular monthly expenses.
Emergency funds are important because if you do not have money set aside and suddenly face the prospect of having to pay an unexpected bill you may not have the money to pay it. This can lead to all sorts of problems. Imagine if you could not use your car as you could not afford to fix it. Or if you and your family had to sit and shiver because your boiler had broken down and you could not afford to fix it.
You can apply for a loan or use a credit card to pay for the repair. I would however be so much quicker and cheaper to use your own emergency fund. Having emergency funds set aside gives you peace of mind that you can cope financially if something goes wrong.
How much of an emergency fund do I need?
If you are thinking of setting up an emergency fund how much should you save is likely to be your first question. Unfortunately, there is no exact answer to that question. This is because no one knows what will go wrong or how much it will cost to fix. As a rough rule of thumb it is believed that having enough to cover between 3 and 6 months of your regular monthly expenses is a reasonable target to aim for.
If you normally spend about £1,000 a month then having between £3,000 and £6,000 in an emergency fund would put you in a pretty decent position to pay for any unexpected costs.
If you do not have an emergency fund then now is the time to start saving for one. You do not have to put aside £6,000 in the above example but having something put aside is better than nothing. If money is tight then even just putting aside £20 a week will mean you have over £1,000 after a year.
Sometimes though there are other more pressing needs for your money especially if you are in debt or behind with your credit card payments. If this is the case then it is better to focus on these problems first but having an emergency fund for food and shelter is still important. If you are looking for suggestions on how to make some additional income then have a look at our 10 tips to make extra money.
Where to save my emergency fund?
Instant access to your emergency fund is crucial as you never know when it will happen. It is important to avoid putting your funds into any account that requires you to give any sort of notice period before you can withdraw your money.
Make sure you keep your emergency funds in a separate account from your main current account. This will remove the temptation for you to spend the money. Ideally, you want your emergency fund like all your savings to be earning as much interest as possible so shop around for a good return. Have a look at the best buy tables on sites such as moneysupermarket and other price comparison websites.
How to start building your emergency fund
As with all savings it is best to set a budget to know what you can and cannot afford. Setting up a regular payment to come out of your main account and go into your emergency fund is the best way of not forgetting or not bothering to build your fund.
Regular payments can be set up by yourself by standing order to transfer money into your emergency fund from your main bank account. You can also ask the bank to set up a direct debit to transfer the money into your emergency fund on a regular basis if you would prefer.
Reviewing your bank account regularly will allow you to see if you can afford to save any extra money into your emergency fund. This will allow you to build the emergency fund quicker and also remove the temptation to spend it.
If you are really struggling to set aside money for an emergency fund then maybe you are spending too much. If so cut back on any unnecessary costs such as coffees on the way to work or drinks after work until you have built up your emergency fund.
What to do once you have built your emergency fund
Once you have built up an emergency fund of between 3 and 6 months congratulations. However, now that you are on the road to building your savings it is not time to stop instead it is time to consider using fixed term accounts. These give better returns and are also a low risk home for your money.
If you are interested in achieving higher returns then it is probably worth looking at stocks and shares. These tend to achieve higher returns but also bear higher risks as the value of your investment can go down as well as up. It may also be worthwhile looking into Peer to Peer lending as this can offer decent returns but like the stock-market it carries risks.
Are there any alternatives to emergency funds?
Emergency funds are not the only way to protect yourself from unexpected disasters such as losing your job. An emergency fund is however viewed as the best but there are insurance products available that offer some protection against losing your job for example.
Payment protection insurance allows you to keep up with payments on your loans or credit card bills if you have an accident, sick or become unemployed. Payment protection plans should be treated carefully as many of these were mis-sold previously by the banks.
If you are concerned about your boiler breaking down you should consider taking out boiler cover. Companies such as British Gas offer boiler and heating cover which includes an annual service and repairing your boiler if it breaks down.