Use your budget to work out how much money you need to cover your essential expenses each month. Your goal is to create a pot of money which can cover these costs in a financial emergency (such as a loss of income).
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What is an emergency fund? ☔
An emergency fund is an instantly-accessible amount of cash that you won’t touch except for financial emergencies. The money is for situations where you face a loss of income or sudden necessary expenditure, such as redundancy or emergency home maintenance. The idea of the emergency fund is to give yourself the time and means to resolve the situation. It is not for facilitating large purchases, but for genuine emergencies.
If you draw from your emergency fund for any reason, your first priority once you get back on your feet should be to replenish it. Treat your emergency fund right and it will return the favour.
How many months of expenses should I keep? 📅
If you’re in the process of paying off high interest debts, we suggest you build an emergency fund of one month of essential expenses. Achieving this is an accomplishment to be proud of, and will give you a bit of cushion to absorb any unexpected problems.
If you are debt-free, somewhere between three and six months of expenses is usually appropriate. It is up to your risk tolerance and situation. For example if you have family support to fall back upon, you may feel comfortable with a shorter emergency fund than if you have a family relying on you.
A larger emergency fund (e.g. 9 or 12 months) may be appropriate if you are in a more uncertain position, for example if your income is unpredictable.
What expenses should I include? 🛒
Your emergency fund should cover some months of essential expenses. It does not need to replace your full income, out of which you would normally make savings and pay for non-essential things.
Go through your current budget and think realistically about which items need to be paid in full each month even in an emergency, and which you could cut back if needed. However, don’t cut back so much that it would cause you hardship. The point of the fund is to reduce sources of concern during the emergency.
You should think about how your circumstances might change in an emergency. For example, perhaps in an emergency you would move in with family and reduce costs. Alternatively, if you currently live with family, or in housing provided by your workplace, an emergency could involve moving out and paying higher rent.
What kind of account should I hold my emergency fund in? 🏦
You should hold your emergency fund in cash, or cash-equivalent, which you can access instantly, and which does not carry risk. Good choices include instant access savings accounts, current accounts, or instant access NS&I savings products such as Premium Bonds (which are 100% guaranteed by the government).
Anything with risk is a bad choice, for example equity investments, P2P lending, or crypto. You don’t want require your emergency fund only to discover it has lost value.
Anything with access restrictions, such as savings accounts with withdrawal notice periods, are also a bad choice – it’s no use having a notice period for access if your emergency is happening now.