Building your first emergency fund is crucial if you want to be financially secure. It is not possible to predict when financial emergencies will occur, but if you have an emergency fund, you won’t have to worry about money. With that in mind, here is an 8-step guide on what it is and how to build your first emergency fund.
What is an emergency fund?
An emergency fund is an amount of money set aside for unexpected expenses. It should be used to pay for unexpected situations such as medical emergencies, car problems, home repairs, among others, and/or for all of your living expenses in the event that you are made redundant from your job.
People tend to think of an emergency fund as something they have to painstakingly build. In reality, you can build your emergency fund by saving up the little money you have left over after paying your bills and other expenses.
Why is it important to have an emergency fund?
The main reason why you need an emergency fund is to save yourself from financial disasters, emergencies, and other unforeseen circumstances. These kinds of events can be really stressful and can affect your finances in a very bad way.
If you don’t have any savings, you will have to resort to various kinds of loans or might even have to borrow money from your family just to get by.
On the other hand, if you have an emergency fund, you will be able to handle these kinds of situations very easily. You can just easily take out some money from your emergency fund if you have to.
You will also be able to enjoy more peace of mind since you will know that you have a financial safety net in case anything happens.
How much money should be in my emergency fund?
Most of us would recommend somewhere between 3-12 months’ worth of expenses in your emergency fund.
It’s a case of “the more the better”, so aim to build up 12 months’ worth in total, as this would allow you to ‘get by’ without any income for a full year if you need to.
For instance, let’s say that your take-home pay after all taxes is £2,000, yet your average expenditure is £1,000 per month – that covers your accommodation, bills, basic living costs including food and water, and various other small costs that you can’t really live without.
In this scenario, each month of pay will pay for two months’ worth of living expenses, so you can build a 12-month emergency fund of £12,000 in 12 months.
What are the most common emergencies?
The most common emergencies are: medical emergencies, car breakdowns, car accidents, fires, floods, thefts and redundancies.
Any one of these can cost hundreds or thousands and as most people don’t have more than a month of expenses immediately available to them while many live paycheck to paycheck, even the smallest emergency can have a big impact on your finances.
How can I save up for my emergency fund?
The first step to building your emergency fund is to look at your expenses and see what areas you can reduce by asking yourself a number of questions such as;
- Do you spend too much on utility bills and are you able to reduce these somehow?
- Do you spend a lot on food and groceries and can you swap expenses brands for supermarket’s own-brand versions, or could you shop somewhere cheaper?
- Do you smoke, drink alcohol or have another regular habit that is expensive and can you reduce those or completely cut them out?
- Do you have credit card debt and can you use a 0% balance transfer to move that to another card with minimal costs?
- Do you spend money on fuel for lots of short journeys where you could walk or ride a bike instead?
I perform this exercise at least once per year and always find something that I can work on to reduce my expenses.
The second step to building your emergency fund is to open a savings account and set up an automatic transfer from your current account to go through after you receive your pay each month. This way, you won’t even see the money in your account and thus are less likely to spend so much.
The amount you set up to automatically transfer to your savings account is an amount that you are guaranteed to have spare each month. So if your take-home is £2,000, your average monthly expenses are £1,000, you might want to automatically transfer £500-800/month just so that you have a little left over in case of an unforeseen last-second expense, then at the end of the month simply manually transfer anything you have left.
What are some great places to save my money?
The purpose of the budget is for it to be easily and quickly accessible, which means that you don’t want to invest it in an asset that you would then have to sell before being able to access the money.
A simple savings account with your bank will be enough for most of your emergency budget and is almost immediately available – simply login to your bank and move the money from your savings account to your current account almost instantly.
Premium Bonds and Cash ISAs are good options to store some of your emergency fund, but you should be aware that the money isn’t immediately available. Premium bonds may take up to two weeks while cash ISAs may only take 1-3 days for the money to reach your bank account.
Keep some of your budget in cash, in case you have an in-person expense to pay and are in the coincidental situation of being unable to access your bank account (such as if you misplaced your debit card).
For myself, this is where I store my 12 month emergency fund:
- 6 months’ worth in a savings account
- 3 months’ worth in premium bonds
- 2 months’ worth in cash ISAs
- 1 months’ worth in cash
How can I keep track of my expenses?
I simply use Excel or Google Sheets.
All you really need to do is look back over your bank statements, record your spending into a spreadsheet and categorise them where you can.
For instance, based on the prior 12 months of spending I can give myself a £200/month food budget, which means I expect to spend up to that much but no more.
I can total together the spending at several different supermarkets throughout the month and see how that compares to my £200/month budget for food, and record how much I spent on that category of expenses in each month.
What you want to be able to do is look back at previous months and easily see that you spent X on food, Y on utilities and Z on entertainment, which then allows you to see which categories of expenses are having the largest impact on your finances and thus which ones to work on reducing.
Your emergency budget in 8 steps
- Calculate your emergency budget savings goal
- Determine what your necessary living expenses are per month and multiply by twelve to get your emergency budget savings goal
- Review your spending habits and make alterations
- Look over your bank statements for the last year and categorise all expenses for each month, then look for ways that you can reduce your spending in each category
- Reduce debt payments
- If you have credit card debt, move this into a 0% account using a 0% balance transfer, giving you a period of time (usually 12-24 months) with no interest to pay and thus lower repayments
- Start saving into a savings account
- Set up an automatic transfer from your current account to your savings account to happen after you receive your monthly salary
- You may want to save 50% of your available cash in a savings account
- Open a cash ISA account
- Find the highest-interest cash ISA that’s available, open an account and start saving
- You may want to save 15% of your available cash in a cash ISA
- Open a premium bonds account with NS&I
- You may want to save 25% of your available cash in premium bonds
- Monitor your spending habits regularly
- Review your spending each month or when possible to make sure you’re on the right track to minimising your spending and maximising your savings
- Invest the excess
- Once you have built up your emergency fund, funnel the rest of your available funds into investments, and for times when you have to use your emergency fund, focus on rebuilding it
Conclusion: Life is unpredictable, but with an emergency fund you can feel safe about your financial situation.
Your emergency fund is your safety net. It’s there for you if something goes wrong. It’s there for you if you lose your job, have a major car repair, are sick longer than expected, have a major appliance break, or any other unexpected expense. A true emergency fund can protect your finances from life’s unexpected events. I hope this blog post has helped you to improve your financial situation. If you have any other questions or concerns about building your first emergency fund, please feel free to comment below.