What is an Emergency Fund? How much should I have in it?
Life will occasionally throw you a curveball. Job losses, car troubles , divorce, or even needing a new roof, can derail your plans and goals. Often, the timing and financial impact of these events are unpredictable. But here’s the silver lining: You can still navigate these rough patches with relative ease by having a reasonable amount retained in your emergency fund.
So, what is an emergency fund? It’s a financial safety cushion set aside to handle the unforeseen expenses that crop up in life. It should also include short-term known expenses, any expenditure you’re certain of incurring within the next five years; such as your children’s weddings, major home improvements or a new car.
The rule of thumb is to stash away at least three to six months’ worth of essential expenses in your emergency fund. Let’s say your monthly essentials—mortgage, groceries, utilities, travel costs, insurance—amount to £2,000. You should aim to have at least £6,000, but ideally £12,000 set aside, separate from your regular savings or investments pots. However, the ideal amount varies depending on individual circumstances. You might choose to save more based on your comfort level. I would say holding 10% of your portfolio in Cash or as an emergency fund is ideal.
We, as advisers, talk about Cash as an asset class, when what we really mean is deposit based savings or similar. So fixed term deposit accounts, Premium Bonds, Money Market accounts and instant access savings all count as Cash. An emergency fund should be saved up in an easily accessible account like a savings account or premium bonds.
An emergency fund is not there to make you money, the amount of interest that you’re making on an emergency fund is irrelevant. The purpose of it is to provide a buffer for unforeseen circumstances as well as short term known expenses. If you need money quickly you don’t have to dip into your longer-term investments. If the Market is low and you have to sell investments at a much lower price than they normally are due to a crisis, an emergency fund mitigates this risk and allows your longer-term investments to recover without you having crystallised any losses. This way your emergency fund can allow your longer term investments to make more money, which is why access is more important than interest.
An emergency fund, also known as a contingency fund, is a cornerstone of financial planning and risk management. It works alongside insurance to provide comprehensive financial protection. While insurance shields you from specific risks like loss of income, longevity, or property damage, an emergency fund offers immediate access to cash for any unexpected expenses that insurance might not cover right away.
Maintaining a reasonable amount in an emergency fund can be overwhelming, once you’ve dipped into it, make sure to replenish it to its original level you’ve setup. Also, should there be any change in your circumstances you’ll need to reflect that change in your emergency fund. If you need guidance along the way, don’t hesitate to contact us at Morrell Financial Management and we will be happy to help.