How Much Should You Keep In An Emergency Fund?
Managing money doesn’t come easily to all of us. Financial literacy is learned, and in many cases, hard-learned – after a financial emergency, or after a period of intense financial hardship. One of the key tenets of financial literacy is the management of risk, from the reduction of risky borrowing practices to the creation of financial buffers between you and a costly emergency.
It is the latter concept that we’ll be engaging with today: namely, the emergency fund. It is something that every household should have, but something that a frightening majority of households do not have. The following guide will examine what the ideal emergency fund looks like, and how to build one effectively.
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What Is An Emergency Fund And Why Is It Important?
First, let’s define the term ‘emergency fund’. An emergency fund is a separate bank account or financial ‘pot’, in which a certain amount of money is kept specifically to soak up the cost of unplanned expenses or emergencies. When a boiler breaks down, repair and replacement can be extremely expensive – expensive enough to completely overwhelm the average family budget. An emergency fund can be essential to preserving the affordability of everyday life, by ensuring essential monthly outgoings can still be covered.
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How Much Should You Aim to Save?
Everyone’s financial needs are different, though some emergencies simply cost the same whatever the shape of your household. Still, with affordability and savings potential in mind, the size of your emergency fund depends largely on the amount of income you make as a household.
Broadly speaking, the ideal emergency fund would hold between three and six months’ worth of your household income. This is enough to cover a period of unemployment, but also enough to cover the outsized cost of a large-scale home emergency repair.
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How To Build An Emergency Fund On A Tight Budget
Of course, some budgets are far tighter than others – and saving up an emergency fund of that size can be difficult, even over a long period of time. In times of urgent emergency, quick loans can be a useful stopgap for covering unaffordable expenses, but they are no substitute for a robust emergency fund. The trick is not to stress about maximising your savings; emergency funds always take time, and knowing you can borrow if necessary is a stress-relieving cushion of all its own.
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Where To Keep Your Emergency Fund And When To Use It
Where you keep your emergency fund is also worth considering, especially when it can help you grow that same fund passively. Your emergency fund needs to be instantly accessible, which rules out some savings accounts and ISAs that require you effectively lock away your money for a pre-determined period of time. Still, there are instant-access savings accounts and ISA products that enable you to accrue relatively high levels of interest – meaning a small additional contribution to your emergency fund each month can help compound your savings.
