Do I Need an Emergency Fund?
Having an emergency pot of cash set aside in the chance of something bad happening is considered good practice. For example, what if you lose your job? Or the wind blows the roof off your house? You need to have readily available funds in case these situations arise.
It may be counter-intuitive, but it’s almost always worth paying off debts before starting to build up an emergency fund.
Get debt free first
An an example, if you have £10k on a credit card at 18% interest rate and £10k in savings at 1%, you’ll be £1,700 per year better off if you pay off your credit card debt.
Is it worth £1,700 a year to have the luxury of £10,000 of cash in a savings account? Absolutely not … not at all.
Paying off your debts: Time for a snowball fight
Start off by listing all the debts you have. Payday loans, credit cards, the mortgage, and don’t forget those ‘Buy now pay later’ deals which are also a type of debt. Get it all down on paper.
Next to each, write down the interest rate (or apr) you are paying. The higher the interest rate, the more you’re paying each month to have that debt. Typically credit cards will be around 15-20%, payday loans more like 100% or more, and mortgages at about 2-5%.
Now it’s time to snowball: that is, start paying off the debt with the highest interest rates or apr first.
It might take a few months or even a few years, but get these debts paid off before you start thinking about creating an emergency fund.
The exception to the rule
- Saving for specific events - It can be a good idea to save up for a specific future event, such as a dream holiday or Christmas. Keep it to relatively small amounts of cash unless you are debt-free, as once you pass the £1k mark, the cost of not repaying debts quickly adds up.
- Interest-free debt - if you have an interest free period, or a really low interest rate, it’s worth holding off until that period ends. Be careful though not to incur penalties Penalties for early repayment - some loans or debt, especially mortgages and ‘buy now pay later’ loans, can come with a penalty for early repayment. If this is the case, leave the savings in an account until the penalty period ends, then repay it.
Should I hold my emergency fund money in savings?
An emergency fund should be easily accessible at relatively short notice - you don’t want something bad to happen, only to realise you have to wait a month to access your money. For that reason, an instant-access savings account is a good idea.
But it’s worth remembering that with the UK inflation rate being so high in the past few years (between 2-3%) and interest rates so low (0.5% or less for over 5 years), your money is likely losing value while sitting in a standard saving account.
It’s worthwhile considering investing some of your savings to give your money the potential to outperform standard savings accounts, increasing your likelihood of earning an inflation beating return. Just make sure you can still make withdrawals in a short period of time (that’s for you to judge, but typically you would want to access emergency cash within a week).
All investments carry a certain level of risk. To alleviate this, it’s best practice to diversify your investments. By doing so, you’re reducing risk by not putting all your eggs in one basket. Think Stocks and Shares Tracker Funds (these funds place your money across thousands of companies so not one company failure can lead to you losing all your money, and best of all they do it for you based on your desired level of risk) versus buying specific company stocks.
Yomo makes it quick and easy to start saving, and to invest into highly diversified stocks and share tracker funds. If this is something you’d like, check out the Yomo app and see if it might work for you.
What is my emergency fund for?
When building an emergency fund it’s important to remember that it is there for times of serious financial need. Of course, it’s up to you to decide what your financial needs are, generally it’s best to keep it for those larger life expenses that you can’t avoid, such as paying your rent instead of paying for the latest iPhone. The rest of the time, pretending it’s not there can help in avoiding the temptation to dip into it.
If you do choose to build an emergency fund, you’ll benefit from peace of mind in knowing that you’re prepared for any financial situation that may arise in the future.