How much of an Emergency Fund should you have

So now you know how my Emergency Fund is structured, I thought I would do the customary post on how much you should have in it!

There is always a lot of talk about how you should have an Emergency Fund, and then how much should you have in there. The normal guidance is 3 – 6 months living expenses in case anything comes up. I tend to flip around quite a lot on this – at one point I have held virtually no emergency funds (as things came up), and slowly built back up. Right now, if I take just cash and cash equivalents, I have just over 3 months of income available to me (having put half of my cash ISA into CTY). I chose income rather than expenses, as I want to make sure I can still fire off my regular savings investments, and to date the only time I have needed to go into my true emergency fund is when I have taken time off between jobs (it has been up to 3 months) so I always question the validity of this. If I was FIRE then I would probably maintain some form of emergency fund to balance out downturns (likely a year or two’s worth), but right now too much cash seems a waste.

I am experimenting with the Go T’ Pub ISA to see how long I need to keep my emergency cash in the stock market before it becomes a no brainer. Given the returns on cash are so low, automatic reinvestment of dividends from an IT should allow it to grow faster, and I need to be prepared for an up to 50% drop in the price and still be able to sell it. Under no circumstances should you consider this without doing enough suitable research, planning etc. This is most definitely not a recommendation for you!

In essence it comes down to how you want to play it. If you earn £10,000 a month (I wish!) and only spend £2,000 a month you probably don’t need much of one, but if you earn £2,100 a month and spend the same £2,000 a month I would suggest you build one, fairly fast! I take the view that I can cope with “small” emergencies quite easily (e.g. an unexpected car repair bill or boiler repair etc.) on the day to day approach, although that means going into the Cash Flow Fund.

Recently I have found myself questioning what would I need the emergency fund for, exactly. Yes an emergency, but that is a rather flippant comment. What is an emergency that I can’t cover normally. Losing your job is the obvious one, so not living pay cheque to pay cheque will help, and you will need some cash, but how fast realistically can you start work in some form again, be it an Uber drive, shelf stacker or another company in the same career (or even freelance).

I am lucky in that I get paid in arrears (so for the work I do in say April, I get paid at the end of April), and that pays for the next month’s expenses (so May) so I am in a strong cash flow from that point of view, or a bad one that I still need to work! I have yet to lose a job, I have always quit on my terms, so I have been able to build up cash so it didn’t come as a surprise.

I’ve held several parts of my emergency cash for years, and never needed it (granted at one point I did use my overdraft for a month or two).

Why am I moving some of my emergency cash into stock? Well, I want my money to work hard for me. Each £10 a month the portfolio generates, that’s £60 less I need to save into the emergency fund. It’s going to be an interesting experiment, and will take a good 3 or 4 years before it bears any real fruit, and it certainly isn’t for most people, but I work on the principle that I can cover most emergencies as is. Even when we moved home, I only used on fraction of my emergency cash even then – my cash ISA didn’t get touched.

That said – the comfort of knowing I can last a few months, continuing to invest, without a thought is a comfort, although taking money out of premium bonds or a cash ISA would be hard for me… but each to their own!

I certainly wouldn’t be happy with less than 1 or 2 months cash readily available but I don’t feel the need for much more than 3 months whilst I am in accumulation phase – the more that I can get into investments, the better!

How much do you keep in your emergency fund?

How my Emergency Fund works

So one thing you will hear throughout the PF community is making sure you have your emergency fund setup and funded. The amount you need varies and only you really know what that is, but of course less than 3 months of expenses can be considered risky and require further work.

The bigger question is – where do you tuck it away? Put it in a fixed bond or account and you get penalised if you pull it out early. You could have multiple fixed accounts and roll them over each year. You could leave it all in one account and forget about it except in emergency. You could stuff it under the mattress for all I know, although possibly a little risky if there is a fire or burglary!

So I thought I would share how I have structured mine, and the purpose of each part of it. All the funds that go in on a regular basis are via standing order almost as soon as I have been paid – pay yourself first remember. This is not a recommendation or approach for how you should save yours, but to help provide ideas for people to tailor to their fund and approach, or just for you to laugh at me, take your pick!

Part 1: Cash Flow Fund (CFF)

So this is my relatively easy cash at hand part of the fund, the first line of defense. The account is linked to my current account so that I can transfer money instantly via mobile app or internet or telephone. I don’t consider this particularly “protected” – it is there to help smooth out the ride. In my monthly updates on expenses you will see some months (e.g. November, December) I had a declared savings rate of 0% or -111%. Whilst this is true, I dipped into (aka emptied) my CFF – this meant the direct debits to my pension and my other half’s ISA (and from this year the Go T’ Pub ISA) all went out as usual – in effect meaning I am transferring my emergency fund into long term funds.

I like this approach as it means I am always adding to my investments no matter what happens and gives me some flexibility.

Part 2: The Rainy Day Fund (RDF)

So I guess this is what you would class as the main emergency fund. It is setup with a building society that I require a separate login to view, can’t access on my phone and have no card for. Generally, I forget about this fund wherever possible – money goes in every month to it (I am thinking of upping the amount slightly) and it ticks up slowly but steadily. I have ducked in and out of it, and I am guilty of saying that I would also dip into for holidays or other big purchases. Please remember folks, holidays are NOT emergencies (although I could put up a damn good argument for it I am sure!). If this were all I had in cash or cash equivalent then I wouldn’t use it for that. This was used to balance out the huge negative savings rate I had in November and towards my tax bill – so now it needs to be repaired. I am too lazy to tart around for better rates, I go for simple, single place and not worry about it. If I had a larger amount of cash then maybe I would (for example when I get close to FIRE and want a year or two in cash, then I will start to think about it!

Part 3: Serious Trouble Fund (STF)

This part of the emergency cash is held in Premium Bonds and is there in case of dire emergency. Not used for holidays, some random home improvement (e.g. carpets or whatever), but out and out emergency. Why Premium Bonds? Any winnings are tax free (and get reinvested in more PBs) – given my tax rate this makes them worth a lot more than regular savings as the equivalent taxed rate would need to be a lot higher to offset the tax. So far I have never had to dip into these savings for over a decade, but it is comforting to know that I have it there “in case”. Should the worst happen and I need it, it is there for me.

Part 4: Last Chance Saloon (LCS)

The LCS is my last Cash Isa. Over the years as the STF grew I transferred more of my cash ISAs into stocks and shares ISAs. As it stands now I have one more cash ISA left which, as part of the Go T’ Pub approach, I will be transferring 50% of it into an Investment Trust. I’ve had these funds in a cash ISA for about 15 years and have never touched it hence I am splitting it between cash and stocks to avoid the money losing its value. Over time, and depending on performance, I may end up transferring the remainder into the Investment Trust as well, but who knows. If I have never needed it for 15 years despite some serious challenges, am I holding too much cash? Who know’s. For now I am happy to be a little different and start reducing this.

So there you have it – a reasonable assortment of places where I keep my funds and how I utilise them. How do you manage your emergency fund?