What is an Emergency Fund and Why is it Important?

What is an Emergency Fund?

An Emergency Fund is a pot of money set aside in a bank account specifically for unexpected, “emergency” costs. You can use it when your car breaks down or if you lose your job, in order to avoid sudden, financial stress. This can save you from having to resort to using credit cards with high interest rates or pay day loans.

How much should you put in an Emergency fund?

The amount you should have in an emergency fund will differ for everyone. The general rule is that an emergency fund should cover at least 3 months worth of necessary expenses. So if you usually pay £1500 on rent, food and other bills, you should aim for saving £4500 as a minimum.

Personally I am aiming to save 6 months worth of expenses. This is because if you ever lose your job, it may take more than 3 months to find, secure and start a new one.

I am also a believer in the way that everything can happen at once. You know that feeling when it is just all going wrong, your car has broken down, the washing machine doesn’t work and now you need a new phone?

I am quite accustomed to this happening so I want to make sure that if that all were to happen, I would be able to cover everything and not have to worry about my finances on top of everything else!

Obviously the more you save in your emergency fund, the more financial security you will have, but don’t let the idea of having to save thousands scare you! The truth is that anything you can set aside in your emergency fund will be a great help to you in a crisis, and we are really just setting a target amount to aim for.

Advantages of an Emergency Fund

So why should you have an emergency fund?

There are many advantages to having an emergency fund, but personally I think the best one is simply knowing that I am in control of my finances and am ready for any situation life could throw at me. Trust me when I say that having an emergency fund can and will help you sleep better at night!

Here are some more advantages of having an emergency fund:

Less financial stress.
Reduces the risk of having to borrow money.
Can earn interest on your fund.
You can fix problems quickly because the money for repairs will be on hand.
Gives you financial Security.

When should you start an Emergency Fund?

No matter what age you are, it is never too early or too late to start building an emergency fund.

In most cases the best time to start one is today!

But what if you are in debt?

It is up to you which you feel is most important, paying off your debt or saving into an emergency fund. But as a general rule, it all depends on what type of debt you have.

If you have expensive credit card debt to pay off or short term, pay day loans, it is best to pay these off first so you don’t get charged even more.

But if your debts are small and manageable or low cost, long term debt like student loans then I would recommend starting to save in your emergency fund straight away.

Where should you keep an Emergency Fund?

The best place to keep your Emergency fund would be a savings account with easy access like an instant access cash ISA. This is because you are not going to be dipping into it very often so a current account would not be suitable.

On the other hand, you need to make sure that in an emergency, you will be able to access your money instantly. Meaning you cannot opt for a higher earning fixed savings account that is locked in for a certain amount of years.

Please understand I am certainly not an expert and I am constantly learning on my financial journey just like you. For a more in-depth look at the financial products available to you, I recommend consulting a financial advisor.

How to Build an Emergency Fund

Now we have determined the importance of an emergency fund, how much you should save, and where to keep your emergency fund, we can finally move on to how to build your emergency fund.

The key to this is understanding that it is a slow process and you will not feel a great sense of pride or relief straight away. Just remember that this is an investment for your future and for your peace of mind, and that something this valuable will take time.

Determine Your Emergency Fund Goal

As discussed previously, the amount that you want to save in your emergency fund will depend on your personal circumstances. If you are stuck, I would recommend calculating your expenses for 3 months and making this your starting goal. If like me you are more cautious, you can then increase this goal later.

Write your goal down somewhere to hold yourself accountable. This way you won’t be tempted to decrease your goal in order to reach it quicker. I also find by writing it down, it makes it more of a real goal to aspire to as opposed to a dream or something that you may never reach.

Decide How Much you can afford to Save

Next, you should consult your budget and calculate how much you can afford to save regularly. Building an emergency fund is a priority, but it shouldn’t cripple you financially or stop you from affording the essentials you need to live.

Work out how much you can comfortably save each month, without risking going into debt. If this is only £50 per month, don’t worry! Whatever you can set aside will be a great step forward towards your money goals.

Set up a Direct Debit

Now you know how much you can put into your fund every month, it is time to set up a regular direct debit or standing order from your regular bank account into your emergency fund account.

There is a well known rule in the finance world that says you should always “pay yourself first”. This means that when you get your paycheck, saving for your future should be a priority and should be done before any other spending so that it is not pushed aside in favour of less important purchases.

Set up your direct debit to go out straight after you get paid. This way you are paying yourself first, and you won’t risk going into debt by transferring it nearly a month after pay day.

Keep adding Extra Income

Your direct debit will be the main way you add to your emergency fund, but it should not be the only way. You should aim to add any extra income you come across into your emergency fund so that your pot will increase sooner.

So if you side hustled an extra £70 this month, transfer it to your emergency pot! If you stopped yourself from buying takeaway coffee for a week, add in what you would have spent! You would be surprised how quickly your emergency fund can grow once you start saving here and there.

If you want more ideas on how to make more money on the side, check out my list of 19 Passive Income ideas for Beginners. There are many easy side hustles that you can start with little to no experience, that will soon help you reach all of your financial goals.

Stay Consistent

Unless you come into serious financial troubles, you should aim to keep adding into your emergency fund on a regular basis. I know it can be disheartening when you are saving but you don’t see results very quickly, but every small amount you save will really help you in a crisis in the future.

You should also aim to not withdraw from your emergency fund unless it is actually a financial emergency. That means no dipping into it to buy the latest phone or a new makeup palette. This is money that you will rely on for your future financial security and therefore should only be used for what it was originally meant for.

Don’t be afraid to Use your Emergency Fund!

Once you have a steadily increasing pot of money set aside, it can be easy to forget it is there, or feel like it cannot be used under any circumstance.

This defeats the point of the fund!

Don’t be afraid to spend your emergency fund when you find yourself in sudden, financial difficulties. It is what it is there for!

I am very guilty of this when it comes to money. Even when I get a gift card for my birthday, specifically to treat myself, I will find myself saving it or feeling guilty about wasting money, when spending it was it’s whole purpose in the first place!

Don’t be like me! If you need to use your emergency fund, then use it! In fact, you should celebrate for saving it up for when you needed it.

I hope this has helped you understand what an emergency fund is, and why it is so important for you and your financial wellbeing.

Let us know your favourite way of saving extra cash in the comments below so that we can all help each other reach our financial goals together!