Having a financial safety net can make all the difference should the unexpected happen. Whether it’s car repair or an increase in household bills, an emergency fund can provide peace of mind to you and your family. In this blog, we’ll explore how you can build one, how much you should aim to save, and practical ways to get started.
What is an emergency fund?
An emergency fund does what it says on the tin. It’s a pot of savings put aside for unexpected costs like your car breaking down or needing to replace a household appliance. An emergency fund can also cover your costs if you’re suddenly out of work for a period of time. This could be due to job loss or for a personal or medical reason.
Once you’ve built up some emergency funds, try not to access this money for any other reason, including to pay regular bills or other expenses. You want to make sure that your cash savings are there should you need them.
A good rule of thumb is to save between three to six months of living expenses. While this might sound like a huge amount, you can start building your emergency savings today by taking just a few small steps.
How to build an emergency fund
1. Start with a budget
The first step is to create a budget. Use your budget to go through all of your monthly incomes and expenses until you’ve got a solid overview of where your money goes every month. If you’ve already got a budget, take some time to look through it and make any necessary adjustments.
Setting up your budget does two things. It allows you to account for all your regular bills and expenses. This helps you to see how much money you can reasonably save every month whether that’s into your emergency fund or long-term savings like your pension.
Having a budget also allows you to see where you’re spending in order to cut costs and use your money more efficiently. If you can see that you spend a little too much on groceries or travel each month, consider shopping around for cheaper alternatives.
2. Open a savings account
Start saving into an account that you can use specifically for your emergency fund. You need a savings account that allows for withdrawals at any time and preferably one that has a good interest rate to help boost your fund over time.
There are lots of different types of savings accounts that allow you to withdraw your money at short notice. For example, Cash ISAs offer tax-free interest on savings up to an annual limit and you can withdraw from them whenever you need the money. Be sure to research your options and choose an account type that works for you.
By ensuring you only use this account for your emergency fund, you’re reducing the likelihood of using your savings for any other purpose. Plus you’ll have an accurate view of exactly how much you’ve put into your savings at any time.
3. Set yourself some saving goals
Saving doesn’t have to be a chore. When you know exactly why and how you’re saving, you can feel empowered and motivated. To help your emergency fund get started on the right track, set yourself some goals for the next year. Try starting with a goal of reaching a certain amount in the first month, then three months, six months and so on.
Remember to be realistic. You want a goal that will push you while still being within reach of what you can achieve. Think about how much money you’re able to save each month whilst considering your lifestyle at the same time. It’s easy to set ourselves lofty goals and then feel disheartened when we haven’t achieved them in time.
4. Focus on small wins
After you’ve set yourself some savings goals, it’s time to break them down into smaller goals. Don’t wait until you reach that £1,000 to celebrate! Instead, focus on saving your first £100. Then, work up to £250, and so on.
This way, you’re setting up regular, little victories. This is a clever psychology hack that gives us a boost while we work towards larger goals. Recognising your achievements while you work towards your big goals helps to keep you motivated. It takes longer to save £1,000 than to save £100 so it can be disheartening to feel like it’s taking ages to achieve your goal. You’re less likely to give up if you’re seeing progress regularly.
And remember, those small wins are still wins! Be sure to celebrate in little ways and feel proud of the progress you’re making.
5. Save every month
In order to build up savings of any kind, you need to save regularly and consistently. The best way to save is to ensure you’re putting money away every single month.
To make this easier, try to automate your savings. By setting up a standing order or automated transfer into your savings account, you can’t forget to contribute to your fund each month. Try to schedule your monthly savings so that they leave your account after payday.
If you don’t have a regular income, you can adjust your savings as necessary. If you have to contribute a little less one month, try to make up for it during the following months. Remember, every little helps and the important thing is that you’re building a habit of saving every month.
6. Only use your savings in an emergency
This can be the hardest, but most important step. In order to have an emergency fund when you need it, you need to make sure you never spend this money on anything else.
While initially this might be difficult to maintain, with the right planning and motivation, you’ll quickly get used to leaving your emergency fund alone until you really need it. Be sure to work with a budget so you have enough money to play with after saving, and remember to celebrate small wins regularly to keep yourself motivated and on track. An unexpected bill or other emergency could crop up at any time so knowing you’ll be prepared should that time come gives you peace of mind.
Tune into episode 29 of The Pension Confident Podcast where our guests discuss the pros and cons of cash savings and pensions. Listen to the episode, watch on YouTube or read the transcript.
Risk warning
As always with investments, your capital is at risk. The value of your investment can go down as well as up, and you may get back less than you invest. This information should not be regarded as financial advice.
