A couple of years ago the Money Advice Service did some research that found that over 16 million people had less than £100 in savings. This means no rainy day fund: no money if your car breaks down, nothing to tide you over if you are off work with sickness; no cushion if you were to lose your job. If you have no emergency fund and the inevitable rainy day arrives, you are likely to have few options. Perhaps you will borrow on your credit card, from friends and family, or get by on your overdraft. For some, a super high interest credit card or pay day loan may be the only solution.
An emergency fund can help you avoid the embarrassment of asking family for help and enable you to avoid getting into debt. It will provide reassurance and a sense of security that you can cope with some of the financial ups and downs of life.
How much should you save?
US finance guru Dave Ramsey recommends that your first step should be to save £1000 in your emergency fund, before putting all of your focus into paying off debt (the ‘debt snowball‘). He then recommends continuing to save hard until you have 3-6 months worth of household expenses. The Money Advice Service also says to aim for around 3 months worth of expenses.
Interestingly, Martin Lewis at Money Saving Expert says you shouldn’t save at all, not even an emergency fund, if you have expensive debts. I understand his logic, but I tend to go with Dave Ramsey’s view that you should pull together at least £1000 whilst paying the minimum on your debts.
As he says, ‘It is going to rain. You need a rainy-day fund.’ If you focus all your resources on paying back your debts without an emergency fund you are likely to be tempted to use a credit card to deal with sudden expensive problems. Then you will have more debt! If you hit any literal or figurative bumps in the road and you find you need new tyres, you can deal with the expense without owing more money to anyone.
Where to start?
The idea of saving 3 month’s worth of expenses is intimidating for many of us, particularly if you are on a low income. Where on earth do you start with your emergency fund?
If you are fortunate enough to have money left over at the end of the month you can start straight away. Set up a standing order and transfer your target amount straight into a savings account.
You don’t want to tie your emergency fund up so that you can’t access it. However, leaving it in your current account means that it is too easy to spend. An instant access savings account will be fine. (My daughter transfers it to me. She knows I will save it for her but won’t let her have it back without a good reason!)
Kick start your emergency fund
If you struggle to get to the end of the month, it may be harder to get started, but it’s not impossible. There are lots of ways to kick start your emergency fund saving, such as:
Budget! If you plan a monthly budget you will know exactly what is available to spend and how much you can save. If you’re not sure where your money goes, keep a spending diary to help you cut out those unnecessary expenses.
Plan your meals and write a shopping list to save money on your grocery bill.
Have a clear out and sell some of your old stuff. You can make money by holding a garage sale, taking a pitch at a boot sale or by selling items at auction. You can dispose of your DVDs and books at Ziffit. CDs can go to Music Magpie. My favourite way to make money from things we no longer need is to sell on eBay.
Look at ways to earn extra income and make sure the extra all goes to your emergency fund.
See if you can haggle down the cost of your household bills. Shop around before you renew insurances, etc.
Peace of mind
An emergency fund brings peace of mind. Remember what it is for, though. An impromptu holiday because you are a bit stressed is not an emergency situation. A washing machine that dies when you have a house full of kids is. A broken mobile phone may need replacing with your contingency fund, but you don’t need to buy a brand new, state of the art smart one.
Birthdays and Christmas saving should be kept separate. You know they are coming round each year! Your emergency fund is for unforeseen expenses.
Do you have an emergency fund? How much do you save?