The emergency fund is something that I reference all the time on Money Talk, often in passing. But I think it’s a topic that’s deserving of a little more attention, especially for those who might not have one yet.
So in this post for the knowledge bank, I’m going to look at what it is, how much money you actually need and how to make the most out of it.
What is an emergency fund?
It’s obvious really – an emergency fund is a small financial cushion that you can fall on when an unexpected cost comes up.
Most people think of it as a backup plan for when they unexpectedly lose their jobs, but you may equally need to dip into it if, for example, your washing machine or boiler suddenly breaks. Essentially, it should cover a sizeable, unplanned expenditure.
While you’re meant to set it aside for an emergency, realistically you can dip into it any time – as long as you’re also disciplined enough to keep it topped up.
How much money do you actually need?
Ideally, you should have enough money to cover six months of living expenses because this is potentially how long it might take you to find a job and get your first paycheck.
However, depending on your circumstances, you could also shrink it down to three months or stretch it to a year.
To find out the exact amount of money you need, you’ll need to work out your monthly budget.
This will include things like your rent/mortgage, bills (gas/electricity, council tax, water, phone, internet and TV), food, travel and any other regular expenses. Looking back over six months’ worth of expenditure is a good way to work out how much you need on average. Then, simply multiply that figure by the number of months you’re covering.
Personally, I would take the six month figure and revise it up by another 5 or 10% – this should build a nice buffer for any unexpected costs if you do end up relying on your emergency fund because of a job loss.
How do you make the most out of it?
The whole point of an emergency fund is that it’s easily accessible so you can use it any time.
But with interest rates so low right now, once you factor in inflation, you’re basically losing money.
That’s why I personally prefer splitting the money – have a portion in an instant access account and a portion in a higher interest account with a wait before the money is released.
Obviously how you split that money is entirely up to you but the instant access portion should be enough to cover any delay in releasing the rest of your money.