Use your budget to work out how much money you need to cover your essential expenses per 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).
What is an emergency fund? ☔
An emergency fund is an instantly-accessible amount of cash that you won’t be touched 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, 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.
What expenses should I include? 🛒
Looking at your budget, you may see some discretionary expenses which you would cut back in an emergency. You don’t have to include these in your expenses calculations – it’s reasonable for your emergency budget to be tighter than your non-emergency budget. 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 you would move in with family and reduce costs. Alternatively, if you currently live with a partner, or in housing provided by your workplace, an emergency could involve moving out and paying higher rent.
How many months of expenses should I keep? 📅
If you’re in the process of paying off debts, we suggest you build an emergency fund of one month of expenses. Achieving this is an accomplishment to be proud of, and will reduce the chance of needing to borrow more to deal with emergencies.
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 job is uncertain, or you are self-employed.
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. You don’t want require your emergency fund only to discover it has lost value (especially as needing your emergency fund may well coincide with loss of value of investments). Anything with access restrictions, such as savings accounts with withdrawal penalties or withdrawal notice periods are also a bad choice – it’s no use having a notice period for access if your emergency is happening now.