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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.

What surprised me – naively – was that some of these ‘down-and-outs’ had been living incredibly ‘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.

Nearly 20 years on from my wide-eyed self, I admit I now wonder how these 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. (This Catch 22 has seemingly been addressed in recent years – I hope?)

Thankfully I’ve never faced such circumstances, so 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 – and the smallest shove is liable 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 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 the payments from some kinds of policies such as income protection insurance are 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, and 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 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, and I think 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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{ 7 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.

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