Creating an emergency fund is a lot like making love to a beautiful woman.
- First, you have to be realistic about the size and shape of what you can put away.
- Then you have to go at it diligently and regularly until you’re satisfied.
- Finally, you must vow never to touch it again unless you have to.
Dubious humour aside (I was channeling Swiss Toni [1], feminism fans!), I’m such a teacher’s pet that I built up my emergency fund as soon as I got a job.
I’ve already explained why I think you need an emergency fund [2], too.
So now let’s run through the ten essential steps to ensuring your emergency fund is ready for nearly anything life throws at you.
Remember, as well as an emergency fund you need to be appropriately insured for the really big emergencies (your house burning down, say).
And to repeat myself, never think you’ll rely on debt in a crisis — that’s like pissing in a lifeboat!
1. Save up at least three to six months income
I’d aim for six months, but admittedly there’s no limit to how much cash you could save for a rainy day. One month is better than nothing — six months should get you through most scrapes, unless your bad luck comes in threes.
If money is very tight, save three months expenses (as opposed to income) at an absolute minimum.
2. Keep your savings in instant access cash
Don’t be tempted to think of your emergency fund as part of your investment portfolio, as before you know it you’ll be chasing better returns. That in turn could lead you to lock away your cash in a longer-term savings account, to risk a loss in bonds, or even encourage you to put it into the stock market.
Don’t go down this road — cash you can get hold of within a maximum of 72 hours is the aim.
3. Get a decent interest rate
Provided your cash is quickly accessible, there’s no reason for it not to earn decent interest. Here in the UK you can get 3% from an instant access account.
With six months income put aside, you’ll be bleeding away a lot of money if your cash is languishing in a poor account. At the very least your fund should grow with inflation.
4. Keep it separate from other savings
Ideally, your emergency fund should be in a different account to any money you’re saving for a car, a holiday or a pet parrot.
If you’re very disciplined you could keep it all together and vow that the first £10,000 (say) is untouchable. If you’re not, put it elsewhere.
5. Know an emergency when you see one
Spotting a new fridge freezer you must have when out shopping or a bargain holiday is not an emergency.
Some people are unused to having cash savings, so as soon as they save their money they’re tempted to spend it. It’s even harder (as always) if your partner has a different mindset to you.
Decide what is — or what isn’t — an emergency at the outset, and start saving for anything else after you’ve built up your fund.
6. Anticipate what could go wrong
Many of us have hobbies, expensive equipment or other liabilities (also called children) that we know will put pressure on our finances.
Systematically go through all your outgoings, and look for realistic scenarios where they could call on your cash. At the very least, your emergency fund should be big enough to handle such events. Ideally, you’d save the extra money on top of your 3-6 months of income, just in case you’re hit by a double-whammy.
7. Make sure you’re properly insured…
This is a whole other article in itself. In short, make sure your property and your life is adequately insured for you and your family. (Though don’t bother with the latter if you’re single).
It may be appropriate to take out income protection insurance, but tread very carefully. Such policies are notoriously problematic in terms of when and how they pay out.
Don’t mistake cash savings for financial invincibility. Big hits to your property or an accident when abroad can dwarf your emergency fund.
8. …don’t scrimp just because you’re insured, either
I know I’m labouring the point, but you should have an emergency fund as well as insurance, not instead of it.
If you’re arguing with an insurer for six months about whether you qualify for income protection payments, you could go into default on your mortgage in the meantime. With an emergency fund, you’ve got a buffer zone.
9. Review your 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. (And as for a mouse…)
Make sure you review your fund at least annually, since expenses and liabilities creep up at least as fast as salaries rise (and probably faster for anyone with kids or a big house).
Top up as appropriate – and it goes without saying you should repay back any cash you withdraw once the emergency has been dealt with.
10. Always be prepared
That’s what they used to tell us in Scouts. It was easier then, of course, since being prepared meant carrying one of those Swiss Army knives with an attachment for getting stones out of horse’s hooves and packing lots of chocolate.
Doing without while you save up your emergency fund is a lot less fun, but the alternative is much, much worse. Always be prepared!
Have I missed anything? Please let us all know in the comments below.