Harold Wilson once said: “I’m an optimist, but an optimist that carries a raincoat.”
Planning for a financial rainy day is important for a number of reasons. Unexpected costs, as the name suggests, don’t give you a great deal of warning, and have a nasty habit of arriving at the most inconvenient of times. It doesn’t just apply to money that needs to be paid out, it can also come in the form of an illness or injury that causes a loss of income.
The Office for National Statistics (ONS) reported in March that the saving ratio for the average UK household reached its lowest level in the final quarter of 2016. With families spending more and saving less, how can they ensure that a rainy day doesn’t turn into a monsoon?
An emergency fund is a common way of preparing for such events, but exactly how much should you save? And are there alternatives to simply saving up a sum of money and hoping that it will be enough?
How much is enough?
There are many suggestions out there as to how big your rainy day fund should be, with common opinions being:
- Three months of salary
- Six months of salary
- Enough to pay for three months of outgoings
Whilst it would be great to have any of these options, it isn’t always possible or affordable for people to save enough before an unexpected cost arrives. So, what is the minimum amount that you need to have?
The answer will be different for everybody, but a general rule of thumb is to work out the minimum you need to get by each month, and multiply it by three. It isn’t possible to plan for every eventuality under the sun of course, but it could put you in a stronger position should your car start making that concerning noise again, or your washing machine decides that it would rather be a kitchen flooding machine instead.
How do I build a rainy day fund?
For many people, putting money aside isn’t easy, and it can be a hard habit to form. Certain techniques can help to keep you focused, such as:
- Paying yourself first, so that you are putting money away as soon as you have it, instead of just saving whatever is left over
- Starting small; saving just £3 per day will add up to £1,095 at the end of the year
- Tracking your spending. It’s often surprising to see how small everyday expenses can add up. If you know how much you’re actually spending, you may spot opportunities to save more money.
These things may sound a bit basic, but combined they can give you a fighting chance when an unexpected cost creeps up on you.
Where should I keep my rainy day fund?
Cash. Without a doubt.
That isn’t to say that you should stash money under your floorboards, it just means that instant access current or savings accounts should be used. The golden rule for any emergency money is to make it readily available should something go wrong.
Aside from inflation eroding it slightly, cash can’t fall in value, whereas investments can fluctuate. This means that your investment could lose value just before you access it, leaving you with less than you originally had.
Are there any alternatives to putting money away?
Saving money isn’t the only method of preparing for the worst. Insurance is another, with products available to see you through times of illness or injury, and to support your family if you die.
1. Income protection insurance
Income protection insurance is a type of long-term cover that helps you if you can no longer work due to an illness or injury. You pay a monthly premium based on factors such as:
- Smoking status
- How much income you need to cover
- Current health
The policy generally pays out until you are able to start working again, or until you retire.
2. Critical illness cover
Critical illness cover is another type of long-term policy, which gives you a lump-sum payment if the holder suffers a specific serious illness previously agreed upon. The payment is generally used for:
- Mortgage debt
- Rent payments
- Adjustments for your home e.g. wheelchair access or stair lifts
3. Life Insurance
Life insurance is reserved for only the rainiest of days, with money being paid out when the holder dies.
The amount of money paid out depends on the level of cover bought, and monthly premiums depend on a number of things such as:
- Smoking status
- Policy length
In an ideal world, the days will never be rainy, and your washing machine won’t decide to ruin your new kitchen floor. This often isn’t the case, and it always pays to prepare in some way, whether that be a large lump-sum saved away or a solid insurance policy taken out. Whichever method you decide on, as with most things in personal finance, the sooner you start to take action, the better.