plonkee money an english-er's thoughts on personal finance

April 4, 2007

five steps: step 3 grow an emergency savings account

Filed under: savings — plonkee @ 4:25 pm

This is the third in an irregular series on the five steps to solid wealth. Step 1 was spending less than you earn, step 2 was paying off consumer debt. Step 3 is to grow an emergency savings account. Its possible (and often recommended) to pay off consumer debt and grow a little emergency savings account simultaneously.

Firstly, the purpose of the emergency savings account is to prevent you from needing to pay to access money in an emergency. By paying to access money, I mean by using an overdraft, a credit card or a personal loan. Having an emergency savings account is likely to stop you sliding into more consumer debt if you have any. It will also generate some income for you in the form of interest if you store it in the right place.

The best location that I can think of for an emergency savings account is in a mini cash ISA. These grow tax free and make more money than regular savings accounts. Whatever sort of account you use, you want it to be earning interest over the rate of inflation (above 4% if you can get it) and you want it to be easy to access but not so easy you spend the money. I’ve found that internet accounts are the best in terms of access, but I have also used postal accounts, which means that it takes me a couple of days to get the money out. I would suggest avoiding accounts with a debit or cash card, as its all too easy to withdraw the money.

The amount of money you need to have in savings depends on the sort of emergency you are likely to encounter. If you lost your job unexpectedly, how long would it take you to find another one? If there was a sudden death in the family, how much would it cost to travel to a funeral and/or take care of their affairs? If the boiler broke in the middle of winter, how much would it cost to buy a new one?

At the moment, my emergency savings are at three months living expenses. This would cover me if one emergency happened, but I’m trying to improve it so that I would be ok if a couple of things happened at the same time. If you are just starting out, it might be easier to set a relatively low goal, say something like £500. In the event of an emergency, this would give you some breathing space before you had to find any more money.

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