This is money set aside to pay for the unexpected. This cash is often called rainy day money and should only be used in an emergency.
Emergency funds can help you cover the cost of unexpected bills such as expensive dental work or a broken boiler. They can also provide much needed cash to help tide you over if your circumstances change such as if you lose your job or are unable to work due to illness. By having this money set aside, you should be in a better position to deal with the unexpected.
This depends on several factors such as your circumstances, the sorts of emergencies you might face and how much protection you already have.
For example, someone with a family, mortgage and loans is likely to need a larger emergency fund than a single person with no children who lives in rented accommodation and has no debts. This is because they have more financial responsibilities and dependants to look after. That's not to say that if you're single with no dependants you don't need an emergency fund. Everyone should keep some spare money accessible, it's just a question of how much.
If you have insurance to cover certain losses or expenses, this might affect how much you need in your emergency fund. For example, you may have house, car or dental insurance which would cover you for some emergencies and expensive bills. Or you may have insurance which would provide you with an income or pay some of your bills if you lost your job or were unable to work due to illness. In these cases you might only need enough in your emergency fund to tide you over until these payments kicked in.
But the general advice is to have enough money in your emergency fund to cover your expenses for three to six months. So if your monthly expenses were £2,000 you might want an emergency fund of £6,000 to £12,000.
Creating emergency funds takes time, but by saving regularly you can soon build up a tidy sum. For example, by saving £100 a month you could build up a fund of £1,200 plus any interest earned within one year.
Some people like to have more than one emergency fund. For example, one fund might be to replace income if they are unable to work and another to cover any unexpected one-off or larger-than-expected bills. There's no right or wrong way of doing this, just choose the method that suits you best.
Regardless of how many emergency funds you choose to have, the money should always be easily accessible such as in an instant or easy access savings account or cash ISA. But remember to keep this money separate from other savings as it should only be used in an emergency.
For help working out how much you would need to regularly save to meet a savings target, use our savings calculator.
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