Last updated in November 2020
Having a fully funded emergency fund is paramount. It protects you during emergencies and gives you peace of mind during other times. With an emergency fund to cover your back, you can say goodbye to money worries.
Despite its importance, over nine million households in Britain do not have any savings, never mind an emergency fund. This means many people are financially vulnerable and at risk of poverty should emergency strike. Find out below what you can do to not end up being one of them.
Monethalia does not offer financial advice. Should you take any action based on the information provided, Monethalia will not be liable for the outcome.
Table of Contents
All you need to know about a fully funded emergency fund
What is a fully funded emergency fund?
An emergency fund describes a savings pot that is reserved to cover you when something goes wrong. For example, you may suddenly find yourself without a job and may need cover for the coming months’ expenses. Or you may suddenly need to have expensive dental treatment.
Note that an emergency should only cover unforeseeable expenses. If you can anticipate that something costly is likely to happen in the future, you should set aside a separate sinking fund to cover this expense. For example, if you drive a used car, you can predict that eventually, it will need some repairs. For this, you should save up a small car repair fund.
How much money do you need in it?
The exact amount of money you need in your emergency fund depends on your individual situation. To figure out how much you need, you have to look at your mandatory monthly expenses. This means money that you have to pay no matter what and typically includes rent/mortgage, food expenses, medical expenses, etc.
Once you know how much you need to spend in a given month, you can use this as a base for your emergency fund. Most people should have an emergency fund for at least three to six months. Therefore, you will need to multiply your monthly expenses by three, four, five, or six depending on your preference.
If you are self-employed or your income is unstable due to other circumstances, you may want as much as 12 months’ worth of monthly expenses in your emergency fund.
How do you save for a fully funded emergency fund?
There are different strategies to save for a fully funded emergency fund. If you have no debt and can afford to save money, simply put as much as you can towards your emergency fund until you reach your target sum.
If you are currently living the payslip-to-payslip life, you have to make room for savings first. You can do this by making a budget. There are ways to save money even if you are tight on money. Mainly, this works by reducing your expenses as much as possible.
If you currently have debt that is not interest free, you should focus on managing your debt before building a fully funded emergency fund. A staged approach, also called a savings ladder, will serve you best.
With this method, you first make a budget for yourself to identify where you can save. Once you have some money to allocate to you your savings, start an emergency fund containing £1,000. This will give you at least some security while you focus on paying off your debt.
Once you have finished paying off your high-interest debt, you can put another £1,000 into your emergency fund. Then, focus on finishing off all remaining debt. When you are debt free, you can finally fully focus on your emergency fund.
Where should you put it?
Your emergency fund has to be somewhere and under your mattress is not the best place. This is because of inflation (and the risk that it could be stolen). Inflation means that each year, your money loses about 2% of its value. This means every year you would have to increase the size of your emergency fund by 2%.
Having to continuously add money to your emergency fund would be annoying and, as it turns out, also wasteful. Instead, you should store your emergency fund in a bank account that provides interest. The interest will guard you against loss of value through inflation.
Furthermore, your emergency fund should also be easily accessible. If you need money right now, you need it right now and not after a 30-day notice period. Satisfying both conditions (interest and easy access) means you should put your emergency fund into an instant-access savings account.
If your fully funded emergency fund is quite big, you can also split it. For example, you could put half of your money into an instant-access savings account, and the remainder into a fixed-notice account or even bonds. However, this is not a requirement. If you prefer to keep things simple, an instant-access savings account will suffice.
All you need to know about a fully funded emergency fund summary
An emergency fund is there to cover your back during an emergency. It should only be used for unforeseeable expenses or to pay your mandatory bills in case you lose your main income. In your emergency fund, you should have sufficient money to cover you for at least three months.
The money should be stored in an account that you can easily access and that pays some interest. Instant-access savers are the most popular choice as they fullfill both conditions.
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