An emergency fund is money you save and put aside to cover a financial shock. This could be losing your job, or a large, unexpected expense.
It can prevent you needing to borrow money or make difficult financial decisions in those moments by giving you savings to fall back on.
How much you need and what an ‘emergency’ is will depend on your situation. Here are some steps to get started.
1. Decide how much you need
It’s recommended you have least 3 months’ worth of living expenses in an emergency fund. If your monthly outgoings – including rent or mortgage and all other expenses – are £2,000, you should start by aiming to have at least £6,000 set aside.
However, the more you can save the better. A bigger emergency fund can help ensure you’re able to handle a large financial shock. So it’s ideal that your emergency fund is 6 months’ worth of living expenses. This means that if your monthly outgoings are £2,000, you’d ideally have £12,000 in your emergency fund.
It may take you a while to save up, but even a small emergency fund is better than nothing, so don’t be discouraged.
Start by looking back at your expenses over the last 3 months to see how much you spend. Then use a budget to work out how much you could save into your emergency fund each month.
2. Start saving
Based on the amount you’ve decided to save, how long will it take to reach your emergency fund goal? It helps to keep a target date in mind and set milestones along the way so you can celebrate progress.
Tip: create a separate savings account for your emergency fund so you’re not tempted to dip into it. Plus, you may be able to earn some interest to add to your savings. Keep in mind, it’s ideal the money is still easily accessed – so you don’t want to it be in a locked savings account or invested.
A good way to stick to your savings plan is to set up a standing order to move money into a savings account each month. If you schedule it for the day you get paid, you’ll remove the temptation to spend it on anything else.
You can also put extra money into your savings account whenever you want. If you’ve got leftover money at the end of a month, why not add it to your savings?
3. Make a clear plan
Whether you’re building an emergency fund for yourself or with someone else, make a clear plan at the outset.
What is an emergency and when will it be OK to use the money? Examples could be:
- job loss
- medical bills
- car or home repairs
Set these out so you’re not tempted to spend the money on something else you may regret later.
4. Keep it topped up
If you do have to use your emergency fund, make a plan to top it back up. It’s important not to let it shrink over time.
It’s also worth assessing your emergency fund on a regular basis. Your expenses can change, so what was 3 months’ worth of expenses a year ago may no longer be enough.