Life is full of ups and downs. You find brilliant opportunities, meet wonderful people, and enjoy marvellous experiences. You, however, may also find yourself in tricky situations and encounter stresses both social and financial that you will need to find your way out of. This article will consider the ‘downs’, or rather a method of diluting the impact of tricky financial challenges, namely an emergency or rainy day fund.
What is an emergency fund?
An emergency fund is fundamentally a pot of money that you have set aside for when you encounter difficult financial situations, say for instance your car suddenly breaks down or you lose your job. It provides a cushion for you to fall back on to help rectify your situation, or to support your basic expenses while you build yourself back up. A need for this was felt especially during the COVID-19 pandemic, where many were suddenly laid off or had new unexpected expenses. A good way of thinking about it is like an insurance policy, but rather than paying premiums to a company, you are paying yourself money to use at a later date, that is free from the restrictions that may be involved with pension and investment funds. In terms of how much you want to have available, the common rule of thumb is around 3 months of living costs, meaning that in the worst situations, most notably losing your job, you can get through a couple months without any income.
What are the benefits of it?
Emergency funds work as a safety-fall-back when things go wrong, giving you room to breathe financially. As such, the key benefit is reducing stress, allowing you peace of mind, especially when making tough and significant life decisions. It allows for more confidence and means you are not left vulnerable if something were to go wrong. As well as this, it is helpful in promoting good saving behaviours. In building up your emergency fund, you will formulate beneficial habits that will stay with you throughout your life. Being able to save and put aside money is key to any major point in your life, whether you are saving for a house or saving for retirement. Finally, it is key to avoiding debt. Many who find themselves in a difficult situation without an emergency backstop often turn to risky solutions, whether taking out loans or using high interest credit cards to get them through. Unfortunately these can come with significant liabilities. Thus, having an emergency fund is a valuable tool to avoid these pitfalls.
What is the best way to build it up?
The key to saving can simply be little and often. Getting in the habit of putting aside a little bit every month will be invaluable to creating an emergency fund. An idea could be to set up a direct debit that will transfer money each month to a separate savings account, allowing for regular build-up of the fund. Keeping the money in a separate account is crucial to avoid spending the money on a whim. We are unfortunately all guilty of spending money foolishly, and placing it in a separate place will keep it out of sight and out of mind.
To conclude, an emergency fund is an invaluable tool to keep you out of harm’s way. Life is unfortunately full of ups and downs, and we will likely all inevitably find ourselves in a tough spot at some point in our lives, whether it is losing your job, splitting up with a long-term partner or your car suddenly breaking down. It will allow for peace of mind and give you confidence when approaching major life decision, especially since you will know you have a fail-safe if things turn sour.
Talk to one of our expert financial advisors today, to discuss your pension planning and achieving your ideal retirement outlook.