No emergency fund? Start one now

By JASON BUTLER

As many people are finding out from the COVID-19 pandemic, being able to cope with a sudden drop in income or an unexpected bill is one of the key elements of financial wellbeing.

This means having some cash savings easily accessible, to help avoid the need to take on expensive unsecured debt or the need to extend an existing home mortgage.

Easier said than done

But just like eating five portions of fresh fruit and vegetables, we all know that we need to save and have an emergency fund, but most people find it hard to do in practice.

That is why it is so important to put in place a system that helps you to develop and stick with good money habits. I’ve previously written about my Smart Spending System, which combines identity, automation and partitioning.

This framework can help you decide where you want your money to go before you receive it from working. What You Need a Budget calls “giving every [dollar/pound/Euro] a job to do”.

How much is enough?

To assess how much you need in your emergency fund, you need to work out how much you spend each month on the essential you, includes things like housing costs, food, childcare expenses, transport, utilities and personal expenses. And you will also need to include debt repayments under future you.

In an ideal world everyone would have between 6-12 months’ core living expenses and debt repayments in an emergency savings fund (I personally always hold at least 12 months’ of core living expenses in an easily accessible savings account, because that makes me feel secure). In the real world it may be that you can get by with a much smaller amount.

Recent research by JP Morgan Chase in the US suggests that lower income households need around 6.2 weeks’ living expenses in liquid assets to weather a dip in income and a spike in expenses. And according to UK debt advice charity Stepchange, an emergency fund of £1,000 could help protect against debt driven by unexpected expenses and financial shocks.

Whether you aim for £1,000 or 6.2 weeks’ expenses, that is a lot less than six months’ expenses and much more attainable as a first step in getting your finances on a surer footing.

Making it easier to achieve

According to behavioural scientists Minjung Koo and Ayelet Fishbach, people are more motivated to complete a goal when their focus is directed to the smaller area, whether that’s progress made or the effort that remains.

For example, if you have a goal of building an emergency fund of, say, £5,000 and you’ve already saved £1,000, it’s better to focus on the fact that you’ve already saved £1,000, not the fact that you still need to save £4,000 to get to your £5,000 target.

But if you have saved £4,000 towards your emergency fund, and only have £1,000 left to save, you would be more motivated by focusing on the smaller amount of £1,000 left to save.

This small change can have big results and is explained in this short video.

Start from where you are

Don’t get frustrated or feel bad about yourself if you haven’t got much of an emergency fund. You cannot do anything about the past. You just need to focus on building up some cash now.

Perhaps sell off old unused gadgets, apply for some financial help from the government, cut the cost of your core bills by finding cheaper alternatives, ask your landlord if they can give you a rent adjustment or change your mortgage to a cheaper deal, consider taking a payment holiday on your car finance, take a second job, disconnect one click online buying, unsubscribe from marketing emails.

One word of warning though: taking payment holidays on rent, mortgage or any other type of finance will cost you more in interest over the long term. So only consider doing this if it is necessary to help you either build up your emergency fund or you are suffering a drop in income.

Get super focused on doing whatever you need to do to build your starter emergency fund now. That way you will be more prepared for an extended downturn or hard financial times. And if things turn out to be better than expected, you will have a nice stash of cash to deploy on more productive and enjoyable things.