Emergency fund building and rebuilding
In my last post, I wrote about how much you should save up for emergencies, which should take account of:
-Your stage of life
-Your access and attitude to borrowing
-The amount which makes you feel comfortable.
If you are responsible for several cars (including those of young adults!), own your home (and maybe a holiday home), and have children and pets, it’s more likely that you’ll have to deal with a financial emergency, so your emergency fund should, therefore, be larger.
Many of our clients are considering whether they might need a larger fund for emergencies in the light of the coronavirus pandemic, and have decided to increase the amount they hold, just in case.
Your emergency fund will need to be used from time to time, so you should expect to need to rebuild it now and then – the research tells us that, on average, we experience more than one unexpected cost a year.
Imagine you have decided that you would like to have £20,000 for emergencies, and your financial planner has agreed that this is the right sum for you. Where should you keep it, and how should you save it up?
It’s important to remember that your emergency fund should be accessible at short notice – there’s no point in having an emergency fund that you can’t use in an emergency!
At the same time, it’s best to separate your emergency fund from your current account, and also from any other regular savings which you expect to use in the year (e.g. for holidays, or for car servicing and other predictable spending).
It’s also sensible to avoid investing your emergency fund in volatile assets, like shares, for example, as you’ll want to be pretty confident of what the value of your fund will be, should you need it.
For these two reasons, it’s better if your emergency fund is kept in an immediate access account or Premium Bonds.
At the moment, Premium Bonds are quite attractive, as interest rates for deposit accounts are as low as they have ever been (it’s almost impossible to get interest of more than 1% interest at the moment); whilst Premium Bonds don’t pay interest, the prizes are tax-free, and you don’t need many wins to keep up with the return on a deposit account.
There are several monthly savings accounts on offer from banks and building societies, which appear to offer higher interest rates than standard deposit accounts, as long as you commit to saving a regular amount for some time.
The headline rates look attractive, but they aren’t usually as good when you do the maths.
At present, it’s pretty hard to beat National Savings Direct Saver account, which pays interest of 1%, regardless of the balance, and allows you to save monthly.
It’s often better not to use an ISA to hold your emergency funds – you are unlikely to get much interest on your emergency fund, so the tax savings are likely to be pretty small (and often there is no tax saving at all, as you can get tax free interest as a result of the Personal Savings Allowance).
If you use up your ISA allowance with your emergency funds, you can’t use it for your investments. Over the long-term, we’d expect investments to generate a higher return, so a stocks and shares ISA will probably save you more tax.
If you’d like some guidance about how large your emergency fund should be, where to keep it or how to build it up, feel free to contact us.