Why having emergency savings is important and how to start

How much money do you have in savings right now? According to Finder, 15% of us have no savings at all and one in three has less than £1,500. Even more worryingly, 70% of UK workers are “chronically broke”, living pay cheque to pay cheque.

By Amy McDonnell

Putting money aside for emergencies can be difficult, especially as the cost of living is rising faster than wages 1. But if you’re able to, building an emergency fund is a safety net for a financial crisis such as:  

  • losing your job
  • an emergency repair 
  • an unexpected cost

If you’re not sure where to start, read on to find out how much you should save, where to keep your savings and how else you can protect yourself financially.

Should you pay off your debt first?

The short answer is yes. Paying off any debt with your savings usually saves you money in the long-term. 

This is because the annual interest you pay on any loans or credit cards is usually higher than the interest you could earn on even a generous savings account. 

Example:

Brian owes £1,000 to a credit card company that charges 20% APR, meaning he pays £200 in interest a year. He also has £1,000 in a savings account earning 1% AER or £10 a year, meaning he’s still losing £190 in interest a year. By paying off his £1,000 debt with his savings, he could save £200 a year and any money he makes on his savings in the future is 100% profit.

In most situations, you’re better off prioritising becoming debt-free before starting an emergency fund. The general exceptions to this rule are:

  • Interest-free or low-interest debt. If the interest rate on your debt is less than your savings account and you’re financially disciplined, you could build up your savings with the debt and you wouldn’t be worse off
  • Penalty fees. If you’re locked into your debt and paying it off early results in a large penalty, you should build your savings until the penalty is smaller

Paying debt off will improve your credit score, this is important as it impacts your ability to apply for loans, such as a mortgage.

How much should you save?

There isn’t a one-size-fits-all approach to emergency savings because everyone’s expenses, income and priorities are different.

While having a goal can help you stay on track, don’t get discouraged if you don’t meet it as quickly as you’d like. Saving is a difficult habit to get into and having anything put away is better than nothing.

Below are three levels that may work for you:

Good

We spend an average of £328 on unforeseen expenses and the largest average payment is £924, meaning that having between £500 and £1,000 in an instant access account could help you in an emergency 2.

Debt charity StepChange also reported that a £1,000 safety net would protect 500,000 UK households from problem debt 3. If this sounds like too much, read our techniques to help you save efficiently.

Better

Most financial advisors recommend having three months’ worth of essential outgoings available in an instant access savings account. 

Calculate your essential expenses by listing your committed outgoings such as the mortgage, council tax and energy bill. Make sure you also include expenses that aren’t paid out via direct debit like childcare or annual bills you may have such as car insurance. 

Total the cost and multiply the number by three to get your savings goal.

Best

Once you have three months’ savings, you could aim for more for added security. But remember, although it’s important to prioritise your emergency savings, don’t neglect your other accounts once you have a secure foundation. 

If you’re interested in increasing your savings, evaluate how much you’re contributing to your pension. Increasing your monthly contribution is one of the most tax-efficient ways of investing your spare change as the taxman tops up any additional income. 

How to start building emergency savings

First, figure out how much money you have left each month. The simplest way to do this is subtract the monthly outgoings from your income. 

Example:

Cecilia and her wife Denise collectively earn £2,500 a month and have joint monthly outgoings of £1,536, leaving them with £964 (£2,500-1,536) in disposable cash.

Once you have this number, decide on a percentage you’d like to save.

Financial advisors often recommend saving around 20% of your annual salary, but that includes long-term savings such as a home deposit as well as short-term savings like for holidays or a wedding.

If you’re saving for the first time, set yourself a small and realistic target, say £300 in six months or £50 a month. Once you get there you can increase your target.

There are two main things you can do to make it simpler: 

  • Open a separate savings account. This way you can see your savings grow and they don’t get lumped in with your other finances
  • Transfer the money as soon as you get paid. You’re less likely to spend it if it’s out of sight

Where should you keep your savings?

Ideally, keep your emergency savings in an instant access account separate to your other money. But that doesn’t mean you can’t reap the benefits of interest while it’s sitting in the bank. 

Keep an eye out for introductory rates for new customers. They usually offer a guaranteed rate for a specific period but take note of the end date and switch to avoid getting stuck with a poor rate.

Other ways to save money

If you’re struggling to save as much as you’d like, reassess your outgoings. There are some bills you can’t reduce easily, such as council tax or your rent. But, there are plenty you can such as subscriptions. We spend an average of £149 a month on subscriptions 4 including gym memberships, music streaming, TV and broadband. While some are essential, you can revisit the packages you have and downgrade if necessary.

We also spend around £60 a year on delivery subscriptions 5 such as magazines, beauty and food boxes. Nearly half of us subscribe to services we’ve forgotten about! Read more about managing your paid subscriptions here.

Other ways to protect yourself 

Building emergency savings is a great first step to prepare for something going wrong. But there are other things you can do to protect yourself financially.

Home insurance

Having insurance for your home can help protect you from unexpected events such as a burglary or flood damage. The average annual home insurance premium costs £144 6 but could save you thousands if you need to repair your home or replace your belongings.

Critical illness cover

With critical illness cover, if you’re diagnosed with an illness defined by your policy provider, you’ll get a tax-free lump sum that you can use however you like. 

It’s less expensive than you may think, with over half of our customers paying just £22 a month 7 or less for our cover. 

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* 15% of us have no savings at all and one in three has less than £1,500: https://www.finder.com/uk/saving-statistics
*  70% of UK workers are “chronically broke”: https://www.theguardian.com/money/2018/jan/25/uk-workers-chronically-broke-study-economic-insecurity