Then, without warning, you lose your job or the engine of the car blows up – or even the doctor tells you there’s a “happy event” on the horizon – suddenly, it’s panic stations - where will the extra money come from? Before you know it, all your best laid financial plans are shot down in flames.
You don't want to dip into that investment portfolio you’ve lovingly created for all those distant dreams. After all, you've built it with those particular goals and time frames in mind. What’s worse, world stock markets are all heading in the wrong direction and your financial advise
r keeps telling you that now just isn’t the time to start selling. If only you had some money tucked away somewhere that you could access quickly, easily and painlessly!
Well, that’s what an emergency fund is all about – and make no mistake, it’s as essential a part of anyone’s financial planning strategy as that carefully crafted long-term investment portfolio.
The next lesson provides some pointers as to what your emergency fund should cover, how long it should last, and where to put it.
Your Emergency Fund: What to Include
First, don't assume that just because you’ve taken out insurance cover against unexpected events such as redundancy or long term disability that such cover removes the need for an emergency fund. Many policies have “qualifying periods” before any benefit is paid, and it’s fair to say that most insurance policies are designed to help you merely meet basic needs rather than maintain a particular standard of living.
Insurance cover won’t help with many unexpected expenditure items such as the car breaking down, the cost of a new central heating boiler, or that unexpected addition to the family – the list is endless. Also, don’t make the mistake of thinking you can always rely on State benefits. Remember, in most instances, these are simply a “safety net” and certainly aren’t designed to enable someone who, for example, has lost their job to continue their current lifestyle. All of the above are important, and we would always advocate adequate and appropriate insurance cover, but this will only complement your emergency fund rather than replace it.
There’s no absolute right or wrong amount to hold as an emergency fund. It’s absolutely dependent upon what you feel comfortable with. Experience suggests that a fund of between 3-4 months basic expenditure or 4-6 months gross income is suitable for many. Of course, a fund of this size won’t, in most cases, be achievable overnight, but this gives an idea of something to work towards – alongside all your other financial aims of course!
Checklist: Where Do You Spend Your Money?
If you prefer, as many do, to base your emergency fund on expenditure, the checklist below may help you decide. Incidentally, assessing your expenditure needs is a valuable exercise as part of your overall financial planning even if it’s not relevant in calculating an emergency fund:
- Home
- Mortgage / rent
- Council Tax
- Water Rates
- Home Insurance
- Contents Insurance
- Utilities
- Gas
- Electricity
- Telephone (landline)
- Mobile phone
- Household
- food
- Clothing
- General household
- TV Licence
- TV rental / HP
- Home entertainment systems rental / HP
- Furniture
- Garden maintenance
- Pets
- Personal
- Loan / credit card repayments
- Childcare costs
- Clubs / subscriptions
- Family commitments
- Gifts
- Travel costs (public transport)
- Education costs (if not shown separately)
- Car
- Loan repayment / rental
- Car tax
- Fuel
- Insurance
- Breakdown cover
- Servicing and maintenance
- Medical
- Private Health Insurance
- Dental Insurance
- Prescription charges
- Non-prescription medicines
The Best Account for You
Once you’ve decided how much to put aside, where should it be invested? The first criterion for an emergency fund is that it should be easily accessible. Waiting 90 days or losing 90 days interest is the last thing you want to contemplate when you need money urgently. Second, because you may need the money at any time without prior warning, “riskier” stock market investments that are subject to fluctuations in capital value are unsuitable.
Generally, a high-interest bank or building society account may fit the bill. One word of warning: keep your emergency fund separate from your day-to-day current account. It exists as a contingency account to meet emergencies, not to supplement your day-to-day spending.
Most bank and building society accounts pay interest net of basic rate tax at 20%. If you are a higher rate taxpayer, you will be liable for a further 20% tax through your annual self-assessment. A Cash ISA will enable you from 6th April 2008 to receive tax free interest on savings up to £3,600 during the tax year (remember you can also invest in the stock market through an ISA up to the overall limit of £7,200).
As an alternative to a bank or building society, your financial adviser may be able to point you towards a moneymarket investment fund, where the manager will invest in a range of cash and short-term fixed interest securities. These funds typically offer good interest returns at little or no risk of losing money.
The main issue should always be ease of access. Shop around by browsing the many websites that feature “best buy” instant access accounts or consult your financial adviser.
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