Much as we love investing at Monevator, even we believe saving for an emergency fund comes first. Building a cash stash to bubble wrap you against life’s bad breaks is probably the most important financial move you can make – after clearing bad debt, of course.

Stuff happens, as they say in polite company, and that’s the starting point for why you need an emergency fund.

Why you must have 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 can send you into the abyss.

You might not be hit by one of the life-changing shocks that kicks people on to the streets. But there are plenty of smaller things that can go wrong:

• Your income may drop unexpectedly, and no longer cover your essential 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.
  

• Your investment platform could go bust, leaving you in need some other source of cash to live on while the administrators clean up the mess.
  

• Your bank might even freeze your current account for some reason.

A sudden divorce, job loss, illness, or a lurch into debt can push any of us into a downward spiral.  But having a good emergency fund on standby helps ensure that you never enter that parallel universe. 

At the very least, you’ll feel better just knowing your rainy day savings are there. 

How much emergency fund should I have?

Save at least three to six months’ income.

Having this amount on hand is a good starting point. It’s not a magic number but a balance of considerations.

Obviously, there’s no limit on how much you could save for a rainy day. You could argue that a plumper cash cushion is best. Indeed, why not save to cover one year or even two?

Your personal situation matters here.

If you’re a single self-employed pigeon fancier, you might want to retain a few months’ more expenses than a couple with full-time roles at long-established companies.

By all means tailor your fund to match your circumstances. But be realistic about how quickly you can save your disaster-dodging dollop.

Set a stratospheric target, and you’ll be directing all of your spare cash into the Emergency Fund, rather than somewhere that does you more good long-term. (Think paying off a mortgage, or investing in higher growth assets.)

Cut your cloth

It’s better to think about your emergency fund in terms of your monthly after-tax income rather than an arbitrary and set amount of cash. 

A £10,000 emergency fund is obviously superior to having £1,000 in emergency savings, but it’s your monthly burn rate that counts. If the bare essentials cost your family £5,000 a month then even a £10,000 emergency fund won’t last long. 

So first, think about how much money you’d need to pay the bills for a month if you cut back on all the non-essentials you can do without in a crisis. 

A budget planner can really help with this step. 

Now imagine you’re out of work for several months because of unemployment during a deep recession, or due to an unfortunate illness. 

Six months’ income (after tax) should get you through that kind of scrape unless you’re really unlucky. 

In theory, six months’ worth of net income in your emergency fund will last longer than six months on an emergency budget. That’s because your income normally pays for life’s little luxuries, too. 

But that extra wiggle room may be a lifesaver if things go from bad to worse.

Say, for example, your car conks out just before a big job interview. With enough in your emergency fund, you’ll be able to afford an immediate replacement in the nick of time.

If money is very tight, then save three months’ worth of essential expenses (as opposed to net income). That is the bare minimum you should aim to hold in your emergency fund. 

Where to keep your emergency fund (UK)

Keep your savings in instant access cash

Do not be tempted to invest your emergency fund, seeking a better return. 

There’s absolutely no point running the risk that your emergency savings are halved in value – just when you need them most – by a stock market slump.  

Remember that stock market falls are correlated with recessions. 

Covering a period of unemployment is a prime use-case for an emergency fund. That’s more likely to happen when the economy as a whole is in recession – also usually the worst time to be in equities. 

Limit your ambitions for your emergency money to earning the best interest rate you can from an easily accessible accounts. 

The type of emergency matters

Broadly speaking, there are three kinds of emergency you could face:

• You have an emergency – Something goes wrong with your house, health, or job.
• Your bank has an emergency – Software or other technical systems at your bank might fail, preventing you from accessing your money. Worst-case scenario they might go bust!
• Your relationship with the bank breaks – If you’re de-banked for some reason then you could find your accounts locked with no explanation for weeks or months – and ultimately even closed.

In the first scenario, it doesn’t matter much where your savings are located. As long as you’ve gone for safe and accessible banks or building societies – that is, you’ve not locked your money away somehow – then you should have no problem getting your cash when you need it.

In the other two scenarios however, the whereabouts of your money is everything.

Location, location, location

If you put your emergency fund into an unusually high-paying savings account with a slightly sketchy niche provider, you’ll obviously regret it if they go bust – but also if you’re ‘only’ unable to access your money for a time.

This isn’t a far-fetched possibility – there’s a decent chance that your own emergency and trouble at a niche bank could coincide. Think Great Financial Crisis 2.0, where a recession sees you lose your job even as it threatens smaller lenders. (Read up on the Icesave drama for a taste from the last go around…)

One practical response is to stash your emergency cash with two providers with different Financial Services Compensation Scheme (FSCS) licences.

This way you’re covered for losses of up to £120,000 per account. And even if one provider goes bust, you can access your money at the other whilst you wait for your compensation to come through.

From a debanking perspective, though, there’s a further wrinkle to consider.

Lloyds Bank, Halifax, and Scottish Widows do have separate FSCS licences, for instance – but they are all part of Lloyds Banking Group.

Put your money with any two of these institutions and you’ll be covered from an FSCS perspective, thanks to the individual licences. But if Lloyds Banking Group decides to de-bank you, then it might conceivably lock up all your money – your current accounts, savings accounts, and investment accounts – at the same time.

A belt-and-braces way to avoid this? Stash your emergency fund cash across multiple instant access accounts – split across different FSCS licences and not under the same corporate umbrella.

Principles in practice

I’ve distributed my own emergency money across three seperate accounts:

1. An instant access savings account attached to my main current account. This is accessible within seconds, with no punitive limits on withdrawals. It holds one month’s spending money.
2. Around three months’ spending money in Premium Bonds, backed by HM Treasury rather than the FSCS. The income is tax-free and the funds are accessible within just a few days
3. Two to three months more spending money in a decent building society account with a local branch. This is totally separate from the banks I have current accounts or credit cards with.

It’s up to you how complex you want to make things. But if anything nasty ever hits the fan, you could be grateful you took such precautions in advance.

Lead us not in temptation

Ideally, your rainy day savings should be kept entirely separate from the money you’re putting towards a car, a holiday, or your dream of owning a parrot.

Of course if you’re a disciplined sort, you could lump it all together and vow that the first £10,000, say, is untouchable. 

But very few of us are saints. So unless you’re expecting to get your halo in the post, keep your emergency fund separate from your other savings. 

When to use your emergency fund

Spotted a delightful new fridge freezer that you simply must have when out shopping?

Come across a bargain holiday?

Those are not emergencies.

Many people – especially younger folk – are unused to having cash savings. Hence as soon as they’ve saved any money they’re tempted to spend it. It’s even harder if your partner has a different mindset to you.

So decide what is — or what isn’t — an emergency at the outset.

You might even want to write down your definition. At least that could avoid the arguments later. Then start saving for anything else after you’ve built up your fund.

We offered some suggestions for valid emergencies near the top of this article.

Review your emergency fund regularly

The money you saved when you first graduated from college won’t be sufficient when you’ve got two kids, a spouse, and a house. 

Make sure you review your fund at least annually. Expenses, liabilities, and inflation all creep up at least as fast as salaries rise. Top-up as appropriate.

It goes without saying that should pay back any cash you withdraw ASAP, once the emergency has been dealt with.

Think about insurance for some emergencies 

Don’t mistake emergency savings for financial invincibility.

Big hits to your property, income, or health can dwarf your emergency fund.

The best protection is a mix of cash buffer zone for smaller mishaps, plus insurance that covers you and your family from catastrophic loss to life, limb, and property.

Check out our useful articles on making the best use of insurance. 

Bear in mind that insurance companies can take a while to pay out, or even fail to do so. Yet another instance in which an emergency fund can be a lifesaver. 

Emergency fund UK: don’t use debt!

A lifestyle that habitually requires you to dip in and out of debt is the type most likely to get derailed by a cash call.

If you bought your kitchen on credit, there’s a strong chance that you’ll try to fend off any unexpected outgoings with your credit card or a personal loan.

But what if your particular emergency is a cut 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 fate deals you a blow.

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, and then start saving into your emergency fund.

Emergency money gives you confidence

The final reason you should build up your emergency cash reserves is because it will give you the security to (separately!) invest in the stock market – and ultimately enable you to meet unexpected expenses without liquidating your equities when they’re down. 

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 her palace walls when the rioters are at the gates should be your role model when investing. Not Corporal Jones in the BBC classic Dad’s Army, panicking at the first hint of trouble. 

Cash on hand gives you that security. With an emergency fund saved to cover your unforeseen expenses, you needn’t worry when the stock market wobbles. 

Start with an emergency fund

Need a last nudge to build up an emergency fund? Here you go: it gives you the bug to save and invest much more.

That’s certainly what happened to The Investor.

And I’m confident that if you’re a saving virgin, then you too will get a buzz from seeing your net worth steadily going up instead of down.

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

Look out of your nearest window, and there’s a good chance you’ll see several expensive tonnes of metal, glass, and plastic sitting idle.

In fact, I am doing that right now.

It wasn’t always this way for me. In the early phases of my investing journey, I managed to avoid the expense and responsibility of owning my own car.

But I could only hold out so long. And between work trips and the need to transport kids quickly and safely, the debate now isn’t whether we need a car – it’s whether we need a second.

Unless you live in a big city with a spiderweb of public transport routes, car ownership can feel mandatory.

But I’m employing every strategy I can think of to avoid ponying up for an extra vehicle.

And with all the app-based doorstep deliveries and on-demand transport options around now, that’s much easier than in the days of the Littlewoods catalogue and the milkman.

A car costs more than the metal

Cars are deeply personal. One person will swear by their 17-year-old Nissan, while another will insist it’s irresponsible to drive something without a top Euro NCAP safety rating.

So to figure out the cost of car ownership, I’ll have to make some broad assumptions.

This won’t match every Monevator reader’s particular needs – or their adeptness with an oil can and socket set. 

But we must start somewhere, so let’s start with the key spending categories:

• Depreciation – The stealthiest cost of all. If you buy a car for £40,000 and sell it two years later for £28,000, you’ve spent £500 per month through depreciation. With leases, the depreciation is baked into the monthly fee
• Opportunity / financing cost – If you put £20,000 into a car in preference to filling your S&S ISA, you’re also missing out on investment growth. Borrow £20,000 to pay for it and you’ll be paying interest on the finance deal
• Running costs – MOTs, servicing, and fresh tyres. (Here’s your reminder to check your tread depth if you haven’t recently!)
• Tax – Vehicle excise duty depends hugely on the age and type of car. Pay-per-mile charges are on the way, too.
• Insurance – Particularly costly if you’re young.
• Fuel – Whether you pump it or plug it, the price of powering your motor adds up.

What’s the price of a Polo, anyway?

Let’s introduce two hypothetical investors. Both want to own a Volkswagen Polo. But they have very different driving habits and financial tolerances.

So how much financial damage can a modest German hatchback actually inflict?

Alice and the new car premium 

Alice has a long commute – 10,000 miles a year – and she can’t afford to be late for work, so she values the reliability of a new car and a warranty.

She decides to buy a brand-new Polo for £20,000 outright.

• Depreciation: £3,000 (new cars shed value like a wet dog sheds water)
• Opportunity / financing cost: £20,000 at 5% is £1,000 per year
• Fuel: £1,500
• Running costs (including tax and insurance): £800
• Alice’s total annual cost: £6,300

Alice’s total commitment to her car is £121 a week. Every week. All for the privilege of driving 10,000 miles a year.

Note that opportunity cost reflects the investment returns you forgo on the money tied up in the car while you own it. Some of that capital can be recovered when you sell.

Gary and his sensible secondhander 

Gary can get the bus to work if necessary, so he’s less worried about a new car warranty. Hence he buys a three-year-old Polo for £10,000.

Gary mostly uses it for errands and weekend trips, and clocks just 7,000 miles a year.

• Depreciation: £1,200
• Opportunity / financing cost: £10,000 at 5% is £500 per year
• Fuel: £1,050
• Running costs (with tax and insurance): £1,000 (older cars need a bit more TLC)
• Gary’s total annual cost: £3,750

Gary is paying £72 a week. Vastly cheaper than Alice’s shiny new motor.

How about skipping the car altogether?

We can do better!

Jess the car avoider

Jess took a close look at the purchases made by her friends Alice and Gary, and she decided she wants to forgo owning a car entirely.

She also realised she doesn’t want to spend a chunky chunk of her day chugging through traffic jams. Getting a job within walking distance of where she lives solved that problem.

Jess earns £25,000 per year. That gives her £21,521 after tax.

And when Alice points out there’s a vacancy paying a much higher £35,000 at her own workplace, Jess runs through the numbers:

Jess would effectively only earn £900 per year more with the new job – albeit she’d also be treated to the joys of being stuck in traffic twice a day, thanks to its commute.

Now let’s acknowledge that Jess could find a cheaper car, just as Gary did. 

But equally, many of the best-selling cars in the UK are more expensive than a Polo!

So clearly there’s a lot of people out there who either don’t do these sums, or who think it’s worth paying a premium for that new car depreciation smell.

Car ownership costs compound

Inspired by Jess and her savvy ways, Alice decides to do better.

Somehow Alice is able to ditch the car without losing her income. (Perhaps she found a different job, or moved to another city. Or she convinced her employer that working from home is trendy again…)

Alice is now spending £6,300 less per year (£525 per month) without a car. The money that previously went on motoring she can now plough into an investment ISA. Over a period of 20 years with a 5% return, she’d end up with £213,915.

Nearly a quarter-of-a-million quid, which could easily be the difference between retiring early or having to continue to slog away at the 9-to-5 for a few more years.

There are downsides

Not everyone can do without a car. You might have medical reasons for needing one, or children that have to get to a distant school. There are myriad other scenarios.

But often car ownership is more of a choice. 

Our family already has one car. Our debate is whether we can manage without a second.

And I’ve found there are lots of options these days that lessen the need to have two Frugalist household vehicles doing the rounds.

Instead of driving to the supermarket, I can get an annual subscription for free grocery deliveries. Most supermarkets offer passes for around £40 per year. Adding on Amazon Prime (including Deliveroo) for £95 per year gives access to still more delivery options.

I could budget for an emergency £20 taxi ride every month. Between the local cab firms and Uber, I’ve found it’s pretty easy to find a ride.

A taxi won’t work for a week-long jaunt to the countryside though. So I could also budget to hire a car for one week a year at £200. There are a couple of traditional car hire places where I live. Turo and Enterprise Car Club are other options, depending on your needs and location.

Added up, these alternatives still only cost £570.

The point isn’t that all of the above are essential if you don’t have a car.

It’s that you can afford to splash out on some apparently extravagant services, because compared to spending several thousand pounds per year on a car, they no longer look so extravagant.

Your mileage may vary

For some people driving is a hobby first, and a mode of transport second. If driving and maintaining your car is something you love, then clearly money won’t come into it.

Or perhaps you have access to an excellent company car scheme. With due consideration of the Benefit In Kind brackets, you can enjoy some very cheap motoring.

But most of us are definitely forking out a pretty penny for every mile travelled and every month of ownership, even if we don’t have to feed coins into a dashboard to stay on the road. So it’s worth working out how much we’re spending and why.

How much would your life change if you didn’t have a car? Would your job become impossible? Could you find another employer closer to home?

Which parts of your life rely on having a vehicle, versus where it’s just nice to have? Could some of the challenges be offset with a bit of targeted spending elsewhere?

If you must own a car (or two)

Obviously staying away from the new car dealerships is the best way to reduce the hit to your future net worth.

Modern cars are so well made that many buyers can realistically keep even a used one on the road for a decade.

Pay cash if you can to avoid financing charges.

Finally, buy the smallest car that’s practical for your situation. It’ll usually be cheaper and it will reduce all the ongoing costs, too.

Buy a fancy pair of shoes if you want to show off. They’ll cost you £20,000 less in the long run.

Every little helps

I was talking to a neighbour recently who bemoaned their frustration at having to drive to the big retail park every time they run out of milk.

Somehow they were completely unaware of a small supermarket that’s within walking distance.

I suppose if I’d been driving myself – rather than walking back from said supermarket – then we’d never have even stopped to chat.

We’re all different. Personally though, I feel a bit richer by reducing my car use.

Not just financially, but physically and mentally, too.

Car ownership is still treated as almost a rite of passage. But if you can swallow your ego and buy a smaller used car, walk around more, and actively try to design your lifestyle around the newer alternatives such as supermarket deliveries, then you might just hit that more important milestone – early retirement – many years sooner than you expected.