We are forever being told that we should each have a well-stocked emergency fund, and that it should contain a certain amount of money. Well, in an ideal world that’s an excellent idea, but who lives in an ideal world?
In the real world, different types of household need different types of emergency fund, and your household needs can change over time. In addition to this, there are even some circumstances where having an emergency fund is a really bad idea.
When shouldn’t you have an emergency fund?
If you have hefty high interest debts and you also have savings, it is good money management to use your savings to pay off your debts. Although it may be a huge psychological boost to have savings in uncertain times, it doesn’t add up financially.
The interest payments you run up with expensive debts on, say, £1,000 will always outweigh the interest your savings can earn for you – even in the highest interest easy-access account. It always costs more to borrow. Plus, if you’re in a situation where you’re missing debt repayments, you’re also likely to incur fines, extra interest payments, and perhaps even do serious damage to your credit rating for the next few years.
That’s why almost all the experts agree that you should get rid of your high interest debts before you begin to save for an emergency fund. Lower interest debts, such as mortgages and student loans, are not included in this scenario.
What’s the three month rule?
It’s regularly quoted that an emergency fund should contain about three months’ worth of wages. That’s take home pay, not the full untaxed amount. The idea behind this is that regular full time employees who have a major personal emergency – usually this is considered to be losing their job – should be able to find a new job within three months.
However, this is only a rough rule of thumb and depends upon a number of factors. For example, what is the general outlook for the job situation in your chosen industry? If it’s at an all-time low then you might need a larger emergency fund, because finding a new job might take a lot longer.
Likewise, your spending habits may well be far more important than your monthly income. If you have high household outgoings and expenses which are unavoidable, you’ll find it much harder to cut back and live on less during the theoretical ‘three months’, so again, bigger savings could be more appropriate.
We don’t all work full time for an employer
Many of us have gone freelance or are otherwise self-employed, either by choice or by necessity. Millions of us are also doing part-time, temporary or casual work. This, of course, strongly affects how often and how much you get paid.
For example, if you’re a freelancer who works on one large project for six months, only gets paid when it’s completed, and works in an industry where employers are often tardy with their payments, you could end up going for nine months without getting any wages. You’ll need more put aside for emergencies, it stands to reason.
Can’t afford an emergency fund?
It’s well known that millions of Brits are not saving this year, and many households are stretched to their financial breaking point. If that includes you, there’s no point beating yourself up about not having an emergency fund. By all means make as many cutbacks as you can though, and try to stay on top of any expensive debts.
If you’re debt free, any amount of emergency fund, however small, can be useful. Even if you can only spare a pound or two per week, it will slowly build up over time. Make sure it’s in an instant access account, that you aren’t paying too much tax on it, and that it’s earning a market leading interest rate so that inflation doesn’t start eroding your savings.
How much do you think people should save into an emergency fund? Or do you dislike the idea of them?