An emergency fund or rainy day fund can help you weather those tough financial times. The pandemic has certainly highlighted the importance of having some money tucked away. But how do you know when you have enough?
In an effort to encourage financial fitness in its customers, HSBC did a survey and found that 80% of respondents had an emergency fund. While this is great news, it doesn’t answer the question of how much is enough.
The three-month rule of thumb
It’s likely that you’ve heard the three-month rule in terms of setting up your emergency savings. Essentially, this means having an emergency fund big enough to cover three months’ of living expenses. Some experts push that to six months for those whose income isn’t stable, such as commission-earners, seasonal workers and the self-employed.
So if your living expenses come in at £1,000 per month, you should ideally have at least £3,000 tucked away. But that increases to £6,000 for those other than the salaried.
Can you save more in your emergency fund?
Let’s face it, in these tough economic times, it makes sense to want a bigger safety net. Three months go by really fast, especially if you’re furloughed. Unemployment rates in 2020 in the UK skyrocketed, resulting in a large portion of people dipping into their savings.
Events such as these also pose the question of whether a three-month emergency fund is enough, considering it’s not that easy to bounce back onto the work treadmill during a pandemic. Increasing emergency savings as much as possible can ease some of that unemployment anxiety.
That being said, it’s important to note that saving too large a sum in a regular savings account can end up costing you. Even if you have the best savings account at the best bank, it’s not going to pay an interest rate that’s higher than inflation. You’ll be lucky to get a return of 1% on your savings, and inflation is currently more than double that.
It’s worth shopping around for rates that teeter closer to the 2% or 3% mark. But accounts offering these rates might limit access to your funds.
Should you invest your emergency fund?
While there are investments that are considered less risky than others, such as government bonds, investments always carry risk. Emergency funds should be immediately available and the capital needs to be protected.
There are a number of products that might be suitable, and you might even consider a combination to give you some legroom. For instance, you could put half in a current or savings account, a quarter into premium bonds, and the remainder in a notice deposit account.
Why have an emergency fund at all?
It’s tempting to think that if you have good credit and a range of credit products with low balances and high limits, that it’s not necessary to save for a rainy day.
The key difference between using credit in an emergency instead of your emergency fund is interest. You’ll pay to use credit, and the amount you owe can quickly spiral if, for any reason, you can’t keep up with repayments.
Credit is also not guaranteed. A credit provider can call revoke an offer of credit, leaving you with little access to a plan B.