Cash for a Crisis. What is an Emergency Fund?
As part of a normal financial planning process, your adviser should be confirming with you any cash reserves that you hold. These cash reserves are often referred to as your ‘emergency fund’ and often overlooked by individuals, but are part of the basic financial planning principles that we follow.
Let’s face it, having a sum of money in cash is not very exciting and may even become depressing, seeing how little that cash is earning sat in your current account. However, when relied upon it can be worth its weight in gold.
The last year has shown us how events can upend our plans unexpectedly and for many having cash reserves to see them through the last 12 months has been so valuable. The pandemic was by no means an event anyone could have predicted, but having cash savings meant that, at a time when people were facing redundancy, economies were in recession and markets were falling, those that had saved were able to cushion the blow of all of these aspects to some extent, whilst the world recovered.
Cash by its very nature is low risk, (nothing is no risk and certainly having funds in cash over the long term is a risk as it loses value in real terms compared to inflation) and is always usually accessible, which is key to having an appropriate emergency fund.
The purpose of an emergency fund is not to receive growth, but for the funds to be there if and when you need them. This could be for all sorts of reasons; to replace income lost for a short time as a result of illness, injury or redundancy, to replace withdrawals from investments or pensions in times of market falls, or perhaps to fund one off major expenses such as house repairs.
How much you should have is a question for debate and a ‘rule of thumb’ guide would be 3-6 months’ worth of your usual expenditure, as a minimum . However, some people feel comfortable with more than this. I recall one client discussing this with me many years ago and he commented that he likes to keep enough in cash to replace his roof on his home if needed. Having given this some thought, it’s not a bad analogy to think of. In reality, we are all different and have different needs and part of our planning process is to work together with you to establish the right amount of emergency fund that you need and that you are comfortable with.
Additionally, if you have debt, you should consider your debt repayments before squirrelling plenty of cash away for a rainy day, especially as over the long term the amount you repay will be substantially more than you borrowed initially.
Of course, you need to keep your emergency fund under regular review. Once this has been depleted, for any number of reasons, it takes discipline and perhaps a change of investment strategy in the short term, to rebuild these funds.
So please think about your own emergency fund and how this sits alongside your own financial plan. Alternatively, speak to us and we can help steer you in the right direction.