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It’s an emergency (fund)!

Emergency fund

Moving to big bad London in the early 1990s, I was shocked to see the large number of homeless people sleeping rough under bridges and in squares in those days.

As I learned more, what surprised me – naively – was that some of these people had been living perfectly normal lives just a few months previously.

A sudden divorce, job loss, illness or a lurch into debt had set off a vicious spiral that eventually put them on the streets, as surely as drink or drug abuse did for the others.

More than two decades on from my wide-eyed self, I admit I still wonder how these particular people had left themselves so exposed to calamity.

I do remember that the loss of a home address was a critical factor back then, as without it you couldn’t claim benefits, receive paperwork or even apply for a job.

Thankfully I’ve never faced such circumstances. And I’m not going to pass judgment on those who have.

But you don’t get off so lightly! 🙂

If you don’t have an emergency fund – or a top priority to build one up – and you’re a Monevator reader, you’ve no excuse!

Why you must have an emergency fund

Anything can happen to anyone, more or less. That’s the starting point for why you need an emergency fund.

When you’ve got a job and good health and your income exceeds your outgoings, setting cash aside might not even occur to you.

But without savings, you’re walking a tightrope. The smallest shove has the potential to send you plunging.

You might not be hit by the life-changing factors that can send people to the streets, but there are plenty of other things that can go wrong:

  • Your income may fall back unexpectedly, and no longer cover your fixed expenses.
  • A member of your family could get ill, and you want to hurry forward treatment.
  • Something might blow up – from the archetypal boiler to a car engine.
  • The roof could literally fall in.
  • A far-flung relative could get married or get cancer. Either way you might want to fly out to be with them.

Being a naturally pessimistic sort of chap, I could go on all day!

Sure, some of the above circumstances will be covered by insurance.

But even then, an event could (/will) happen that isn’t. It’s the nature of the beast that emergencies are often unexpected.

Also, remember that insurance payments can take a while to kick in, and winning the payments from some kinds of policies such as income protection insurance can be notoriously hit-and-miss.

Better to have savings in place, and insurance as a back up.

Think you’ll use debt? Don’t!

Lifestyles where you habitually dip in and out of debt are the most likely to get derailed by a cash call.

If you bought your kitchen on credit, you’ll assume that any unexpected outgoings can also be met by your credit card or a personal loan.

But what if the emergency is a drop in your income? Increasing debt payments in the face of a falling income is about the worst thing you can do, short of selling a kidney.

Avoid this at all costs, by saving cash in advance and shunning debt.

Even if your salary is secure, increasing debt payments will leave you more vulnerable when the next cash call comes along.

Companies go bust due to cashflow struggles. Debt is often the multi-tentacled monster that drags them under.

People are the same. Get out of debt, then starting saving a cash fund.

Cash gives you confidence to invest

The final reason why you should build up your cash reserves is because it will give you the security to (separately) invest in the stock market, or even to set-up a side business for passive income.

If all your worldly wealth is going up and down with the mood swings of 10,000 excitable and over-paid fund managers, I wouldn’t blame you for being tempted to flee when the market crashes – but that is your worst possible move.

With a sufficiently big emergency fund in place, you’ll find it easier to develop the lofty disdain necessary for long-term investing.

Marie Antoinette offering cake from within the palace walls when the rioters are at the gates should be your role model when investing, as opposed to Lance Corporal Jones in the BBC classic Dad’s Army, panicking at the first hint of trouble.

With cash saved to cover your expenses, you needn’t panic. Problem solved!

Start with an emergency fund

A final, final benefit of saving up an emergency fund is it gives you the bug to save and invest much more.

That’s certainly what happened to me. I’m confident that if you’re a saving virgin you’ll get a buzz from seeing your net worth going up instead of down, too.

Before you know it you’ll be wondering how to start investing!

In part two I go into practical detail about how to set up an emergency fund.

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{ 33 comments… add one }
  • 1 Lee September 30, 2009, 7:11 am

    All excellent points that pretty much follow precisely my new philosophy. Some PF bloggers (and a lot of the general population) seem to support using fast credit (e.g. credit cards) as the emergency fund which is all well and good – until the emergency is redundancy. Then what do you do?

  • 2 The Investor October 1, 2009, 8:49 am

    Yep, using credit is one of those ying/yang things.

    A lot of people use credit cards for everything. I know women who proudly go on plastic-powered shopping sprees as if it’s clever and aspirational to give some faceless corporation a load of extra income on a Saturday morning.

    Once you’ve realised (i.e. got furious about!) how you’re throwing money away by paying a credit card or loan company just to buy something early – plus exposing yourself to massive extra risk, as you say – then it’s easy (and almost always a good thing) to go the other way and avoid it like the plague.

    I’ve even avoided debt in my small businesses, which has led to disagreements with – you guessed it – the credit junkies on the team! I haven’t paid a single penny in interest on a loan for well over ten years, and only the student loan before that.

    The above said, I do use credit cards for their other benefits – such as consumer protection and cashback. My main card is set to direct debit payment so there’s no risk of any interest. Doing this you basically get a 45 day interest free loan from the supplier, and are rewarded for it. 🙂

    If there’s any danger at all that you’ll fall back into actually taking on debt with a credit card, however, it’s safer to cut it up and bin it.

  • 3 Financial Samurai May 21, 2010, 5:21 pm

    Again, everything sounds like an emergency here!

    Like I said… if you are thinking in “emergency fund” terms… you are scraping the bottom of the barrel and need to do more!

    Where is Lee BTW? He disappeared!
    .-= Financial Samurai on: The Emergency Fund Fallacy =-.

  • 4 The Investor May 21, 2010, 5:48 pm

    Well, we’ll have to differ. As I said elsewhere, in my view an emergency fund is exactly what it is – a cash fund that enables you to cope with unexpected things, entirely separately from your everyday savings aspirations.

    You may (did! 😉 ) on your blog that if you’ve got $100,000 in the bank you don’t need an emergency fund, but that’s like saying if you’re Meggan Fox you don’t need to wear makeup. Not relevant for most people, who must effectively lock up most of their long-term savings in assets such as equities on an uncertain time horizon.

    If they don’t have cash and emergency strikes, they’ll have to go into debt. If they do have a tonne of cash like you suggest, then they’re going to retire poorer than they need to because of the terrible real returns.

    As for Lee, I think he found love. 😉

  • 5 Frugal November 18, 2010, 10:11 am

    Hi there. Great site – keep up the good work!

    I’ve now built up my emergency cash fund. Now the big question – where do I store it, or shall I allow inflation to eat it up?!

    I’ve been trying to buy Barclays Index linked bond but nobody has any information about how I buy it (I even have the ISIN number but cant find it on the market – they only speak to IFAs when I call direct).

    Please help!

  • 6 Ethan's Money September 8, 2012, 9:57 am

    I’m in agreement on the need for a robust emergency fund … or at the very least, an emergency plan that will get you through six months if you lose your job. It doesn’t have to be cash savings, you could take into account redundancy cheques and other investments.

    However I’m very wary of relying on credit cards or overdrafts to tide you through in the event that things go wrong. They are not committed facilities. The banks have sophisticated systems to identify when your financial circumstances change. If regular salary payments disappear, they will pick it up and they will be on the phone to you.

    You might find that the credit card limit or overdraft facility that you were relying on to support you through redundancy suddenly disappears!

  • 7 Jonathan April 29, 2013, 5:20 pm

    Some of the emergency fund needs to be in cash, not bank deposits, as the Cypriots recently discovered.

  • 8 John B September 26, 2018, 1:31 pm

    I don’t think you should dismiss credit cards so quickly. Perhaps if you are a regular user of debt, and load and unload cards frequently, you might get sucked into a debt spiral. But if you never even take out car loans, and pay cc’s in full by direct debit, then its better to have the £10k to go on them, to be cleared from savings, than to have £10k doing nothing.

    Flexible ISAs are also better than current accounts, provided you can return the money with the tax year.

    And any hit you might have from a forced sale of equity that might take a month to organize is still better than the drip-drip of loses of the 3 years salary in cash some believe in.

  • 9 The English Investor September 26, 2018, 8:29 pm

    At first, I struggled with emergency funds. How could you be so unprepared that you need to use savings? After all, isn’t that the point of insurance? To cover the unexpected.

    I now see the benefits. An important one is that it is a good way to start saving. A second one is that it teaches discipline: there is cash in your account and don’t spend it.

    On credit cards, I think it is fine to use those as long as you have the cash already available to repay the credit card.

  • 10 Matthew September 26, 2018, 8:37 pm

    Could use an offset mortgage…

    I think, in favour of emergency funds, that if it means you can self insure to some extent, then you can consider the premiums you save to be a hidden extra return on cash, especially if the same pot can cover multiple improbable emergencies, this hidden return/savings beats equities

  • 11 Kris September 26, 2018, 9:10 pm

    I count my mortgage overpayments as PART of my emergency fund. Currently have a reserve of 9 months. It’s reducing my interest owed but if needs be I can stop paying my monthly mortgage for that time.

  • 12 weenie September 26, 2018, 10:06 pm

    Before I set up my emergency fund a few years ago, I swore by my 0% credit cards.

    But having spare cash is a lot better. Mine (when I finish topping it up, having dipped into it recently) covers around 4 months’ worth of expenses and is mostly sitting in higher interest current accounts.

    I’ve kept my credit cards however, as they will now be used as an absolute last resort.

  • 13 Peter September 27, 2018, 8:48 am
  • 14 TheFireShrink September 27, 2018, 11:47 am

    I always used to consider my credit cards as my ’emergency fund’, as both MrsShrink and I have a couple of 2 year 0% interest deals which would tide us out, and we ensure that our household outgoings could be managed by one of our salaries alone. Recent job changes and moderate anxiety about cashflow mean I’m now building my emergency fund, and trying to reduce my credit card balance. I still tend to use credit cards for big purchases though, as it’s 0% interest and offers protection.
    My current struggle is whether to include your emergency fund when actually calculating your portfolio. Lots of people talk about 10+% of their allocation being in cash, but is this their emergency fund, or a bond locked away? With 5% interest rates achievable through current account juggling does your portfolio cash allocation have to be classically bonds?

  • 15 Christian Graham September 27, 2018, 1:12 pm

    Think I’m in agreement with John on credit cards. They can give you an additional buffer, convenience and time.

    Once I had to arrange a flight for the missus & I to get us to the other side of the world within 24 hours to attend an unexpected funeral. Half an hour later, we had a flight booked with the local travel agent and a cab back home to pick up passports and essentials for travelling. 20 hours later thanks to a mixture of trains, planes and jeeps we got there. A credit card was absolutely essential in enabling that – and it gave me time to collate funds from various accounts to pay it off before it became due.

  • 16 The Investor September 27, 2018, 1:56 pm

    @Christian — Well if a credit card was absolutely essential then that was because you didn’t have cash savings. 🙂

    As it happens I would have booked all those flights and hotels through a credit card anyway, for the protection. But I’d feel better knowing it was all backed by cash.

    And as I say in the piece, there are times when credit cards don’t work. If for instance you find yourself in say a divorce at the same time you lose your job, or some other economic calamity.

    Of course you might say it wouldn’t happen to you, and if you’ve abundant assets and low debts that may be true and the piece isn’t going to hit the spot to the same extent.

    But the way I started the post was genuinely true. I did speak to some of these people doing student charity soup kitchens, and it was very eye-opening. There are people, not many, but some, who are top of the world in January and on their uppers by September (say). They are almost certainly running closer to the wind than most readers of this site, but certainly not closer than all effusive users of credit. 😉

  • 17 The Investor September 27, 2018, 1:58 pm

    @Peter — Ack, of course! And to think I’ve had him demoted here ever since V1 of this article was posted a decade ago. Cheers, fixed now!

  • 18 David C September 27, 2018, 2:23 pm

    It might be worth looking at fixed-rate Cash ISAs as a home for a real emergency fund. Unlike normal fixed-rate savings accounts, they normally allow withdrawals (I think that this must be an ISA rule: I’ve certainly never found one that didn’t). There’s always a penalty, so you wouldn’t want to use it for money you’re _likely_ to need early, but it’s a good backstop for the “roof falling in” fund.

  • 19 Matthew September 27, 2018, 5:29 pm

    I think as well spread it across a couple of banks in case a bank IT failure is your emergency

  • 20 David C September 27, 2018, 5:47 pm

    @TheFireShrink – Using bonds for your cash allocation goes back to the days when bond prices and equities moved in opposite directions. It’s probably still true that investment-grade bonds and gilts are less volatile and less risky than equities, but the price of all of them has been pumped up by QE etc. So I think it makes lots of sense to use actual cash for at least part of your cash allocation. OK, you may lose a bit after inflation, but (as TI/TA/guest? says) the cash/bonds are there for insurance, and normally I expect to pay for insurance.

    As for including the emergency fund in your cash allocation, I’m not sure. You can’t spend it on a new boiler and rebalancing at the same time. Also, the size of your emergency fund needs to be driven by your potential emergency spending requirements, not as a proportion of your overall pot. If the markets crash by 50%, the price of a new roof probably won’t, and you don’t want to have to sell equities to fix it.

  • 21 John B September 27, 2018, 6:58 pm

    Nobody wants to sell equities at a loss, but there is no point being obsessed by it. Any normal emergency will only result in selling a small fraction of the equity, so you really won’t be affected overall by being a forced seller.

    Its also a bad idea to think of rare, but predictable items, like a new roof or boiler as emergencies. Anyone doing financial planning should put aside money for such things with a 20 year horizon, and the best place for money over 20 years in equity. Its all about self-insuring for the vagaries of life, but investing the premiums.

  • 22 Gordon September 27, 2018, 7:55 pm

    Raising cash in a hurry can be surprisingly hard. I want to raise £100k in the next few months. I won’t get a mortgage as my employment history is primarily self employed. If i sell shares I will need to sell £150k of shares and pay a shed load in capital gains tax…… I obviously don’t want to do that.

    I’ve a meeting with Barclays next week about borrowing money against my share portfolio. I gather I can borrow money at 2.7%. Happy days if Barclays don’t want to bum me with other charges.

  • 23 Lloyd September 27, 2018, 8:40 pm

    I think having a credit card to use as an emergency fund is useful, but…

    Many people (and I used to be one) put all there monthly spending on a credit card and then pay it off the following month gaining free credit and often points/cash back.
    I believe there can be 2 problems with this. Firstly, you can very quickly be living a month in arreas, which can be a major problem if you suddenly lose your income. Secondly, spending using a credit card can feel less ‘real’ than spending using a debit card (or cash), which can psychologically encourage spending – the perils of which have been well covered previously on this site!

  • 24 ermine September 27, 2018, 9:33 pm

    I was reasonably convinced by Jacob ERE’s assertion that he don’t need no stinkin’ emergency fund, he has a credit card. But I believe he was young, free and single at the time. I’ve forgotten which lady financial journalist it was who said “never take finacial responsibility for something that eats” but once you’re in that position I’d say cold, hard, cash beats the credit card option hands down.

    Although I was intellectually convinced by Jacob’s CC argument, I could never bring myself to actually do it. But then I stupidly spent a lot of 2009 paying off my mortgage and into a cash ISA as well as my S&S ISA, I would be better off now if I’d dropped the cash ISA which was my emergency fund. I never used it, eventually put it in my S&S ISA.

    It’s not always what’s right, it’s also what you can make yourself do.

  • 25 Nigel September 27, 2018, 10:00 pm

    I use NS&I Premium bonds to hold my emergency fund. Pays >1%, tax free, easily accessible. Save and forget (except for the day you need it!)

    ……plus small chance it may be the best investment you ever made!

  • 26 Bastiat September 28, 2018, 7:16 am

    “Marie Antoinette offering cake from within the palace walls when the rioters are at the gates should be your role model when investing”
    You do know Marie Antoinette was guillotined?

  • 27 Bastiat September 28, 2018, 7:19 am

    Plus big chance it may be one of the worst investment you ever made… (inflation >>> 1%)

  • 28 The Investor September 28, 2018, 8:08 am

    It’s quite right to think about inflation with one’s portfolio, but that is only one of many factors. An emergency fund is not there for returns.

    At the moment you can put money into a cash account offering some level of access and earn around 1.25% to 1.5%. Currently, as for much of the past ten years, that’s below the rate of inflation. But it’s only c. 1% to 1.5% below. It’s not 10% below, say.

    For much of the past ten years you’ve perhaps had to pay 1% to 1.5% a year — on the relatively small amount of money allocated to emergencies — as a cost of having an emergency fund. I think that’s a manageable price to pay for security. It is a consequence of living after the largest financial crash since the war.

    Prior to 2008 it was easy to have money on deposit earning say 2-5% *above* the rate of inflation, if you were savvy about it. I think we’ll see such times again.

    But anyway, the principle of the emergency fund is not negated by the fact that real rates are low right now. That’s just unfortunate.

    Low rates do not mean that your boiler doesn’t blow up, or your kid doesn’t call from abroad saying they don’t have medical insurance, or you don’t find rising damp in your cellar.

    We’re ten years into a global recovery and in much of the world (principally the US but also in aspects of the UK) the same time into a long bull market. People are confident, happy, and decry the idea of paying 1% or so a year for safety.

    I get it. 🙂 But it doesn’t obviate the need for an emergency fund, nor its ideal structure.

    If you’re in your mid-40s, say, and have 10-20x your annual expenses in accessible equities (i.e. not a pension) perhaps you feel happy to roll the dice on using credit cards and selling assets if you have to, or putting it on plastic, rather than having a few percent of that total exposure left in cash, reducing your annualised returns by a few basis points over the years. (Ahem.)

    Your call. 🙂

    Just don’t forget you can lose your job at the same time as shares fall 30% or similar, and you may then need to sell a bunch of them because you’re hit with a couple of financial meteors. This stuff happens, not often but it does.

    It’s the same reason there are life jackets under a plane seat. Many people would probably choose to pack extra duty free shopping or save £10 on their baggage allowance and not have a life jacket available if given the choice. How often does a plane crash, they’d ask, perhaps reasonably? Basically never.

    But if yours does ditch in the middle of the Pacific, how much would you give for that jacket then? Everything?

    This is leaving aside all the other advantages of having a nice fat cash buffer between you and the vagaries of the economy and the markets, as mentioned in the article.

    After buying my flat and furnishing it (argh!) I’m the least cash-insulated I’ve been for 20 years, and it has made me more hesitant as an investor, for example.

    But each to their own. I don’t think alternative strategies to using cash are merit-less, let alone madness. But I do think they’re a repositioning of risk/reward, not clever ways to get out of the realities of life.

    You allocates your money and takes your choice. 🙂

  • 29 The Ig September 28, 2018, 4:05 pm

    Why not use the (cashback/points) credit card to pay for the emergency, giving you time – if required – to get funds to the account to pay the card off ? Then even the emergency is making you a bit of dosh on the side, making it marginally less expensive.

  • 30 The Investor September 28, 2018, 4:30 pm

    @The Ig — If the credit card payment is backed by cash savings, then that’s what I’d do. The cash account is still the emergency fund. The credit card is a tool or conduit.

    If the credit card is backed by nothing, so you’ll go into debt, or by the requirement to be a forced seller of assets at a time you didn’t choose, then you’re doing something that I wouldn’t recommend, personally.

  • 31 Fatbritabroad September 28, 2018, 11:46 pm

    For me I’ve Gone a half way house. 8 to 10k cash which is 3 to 4 months emergency fund and the rest in equities and p2p which i can realise alot more relatively quickly. Ere was a big factor in this. I had 20k in cash before but it didn’t make sense weighing up the risk of some random black Swan even vs the opportunity cost. Its a risk but a calculated one same as having half my mortgage in investments but not paying the mortgage. Its basically leverage and as long as my net worth (currently 460k) is comfortable vs the risk (about 8k in cash) then I’ll accept the risk In the hope of more gains,

  • 32 John B September 29, 2018, 7:37 am

    p2p seems an unwise place to get cash in a hurry. My dabbling with p2p has left me with a scattering of accounts with bad debt that will take years to resolve, and even if the loan is being serviced, finding a buyer to sell to can be hard even in these stable, if fragile times. Not a good situation if you are losing your job as others are losing theirs. Even the companies with collective accounts don’t have the reserves if there is a loss of confidence and a run.

  • 33 Fatbritabroad September 29, 2018, 7:41 am

    True and i’m not really counting it as part of my emergency fund. I also have 70k of equities as well. If i need more than 7k I’ve got credit cards and an overdraft. Itd have to be something pretty major

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