How to start building your emergency fund

Here's a question you might be asking:

How much do I need in my emergency fund?

If you looked through different sources of material in the personal finance or financial independence space online you will find a range of recommendations based on some general consensus or based on the writer’s personal preference. You might see recommendations of £1,000, or one month of your monthly costs, or three months, or six months and so on.

None of them are wrong, so it’s not my aim to try and find which one is better and which one isn’t. However I do think that everyone is different and will have different factors that affect their decisions, so I will focus on how you get your emergency fund started and how you can build it up over time until it reaches an amount that suits your comfort and personal situation.

When I went through my first emergency event and had my bank accounts reduced to zero I decided to start by aiming for a relatively easy target just to get things going again. My target was to reach one full month of my monthly income after tax, and I knew that after I hit that target I could re-plan my next steps.

Let's say your total income after tax in a month comes to £2,900 with £1,265 of that being spent towards essentials such as housing, groceries, bills and so forth; that would leave you with £1,635 leftover to work with each month. With that leftover money you will try to build up to an amount of £2,900 and that will be one month's worth of income sitting in reserve, giving you some firepower and ability to deal with a financial emergency.

Even though the original question of "How much do I need in my emergency fund?" is sensible, I think a better question to ask is:

How do I start building my emergency fund?

When it comes to starting your emergency fund an important thing to keep in mind is that the longer it takes you to reach your target amount, the more exposed you are to the risks of a financial emergency happening.

Let's say you decide to put £100 each month into your emergency fund; assuming a starting point of £0 it would take 29 months in total to reach that target of £2,900 or one full month of income.

Target emergency fund value: £2,900

Monthly Contribution: £100

Number of months to hit target: 29

(£2,900 ÷ £100)

This might be fine if no emergencies happen for nearly 2 and a half years, but considering that you have almost nothing to fall back on in terms of money during this time that type of exposure for that length of time probably isn't worth it.

It would be better to take some action to build up the emergency fund slightly quicker by making some smart decisions around the money you have leftover after paying for essentials. This would be the £1,635 you have leftover each month.

There are a few approaches you could take:

  1. Maximise contributions from your leftover money, to hit the target at top speed.

  2. Make regular contributions of a set amount, leaving some flexibility in your budget.

  3. Optimise between speed and flexibility by working through the numbers.

Maximise contributions

With this approach you will put every single penny of your leftover money at the end of each month into your emergency fund. You will stop spending money on anything else besides the essentials to ensure that you're putting as much as possible into the emergency fund. This keeps going until you hit the target that you have set.

With a target of £2,900 and monthly contributions of £1,635 the emergency fund will build up as follows:

Target emergency fund value: £2,900

Monthly Contribution: £1,635

Number of months to hit target: 2

(£2,900 ÷ £1,635)

Assuming you get your monthly income at the end of each month it takes just two months of contributions to hit the target. There's even a little bit of money remaining from the second month's contribution that you could then spend on whatever you wanted.

The benefit of this approach is the speed in which you can hit your target, 2 months using the above example, meaning your exposure to any financial emergency will be minimised to the shortest amount of time possible. With your emergency fund set up you will be able to rest a little easier at night knowing that you’re fairly well prepared.

The drawback is of course the lack of spending flexibility during the building process. All of your available money goes into your emergency fund and you can’t spend any of it elsewhere until you’ve hit the target.

To be honest, if it’s only for two months then it’s not that bad; you just need to be focused and disciplined for a relatively short amount of time and then you’ll have reached your starting target for your emergency fund.

However, keep in mind that this is only an example and in your own situation it might take longer. For example, if it takes four months or longer then it becomes less reasonable to take this approach despite it reducing the time of your exposure to financial emergencies. You have to take into account the psychological aspects and discipline required to maintain that level of contribution.

By going for an extended amount of time without any spending flexibility or breaks from the building process it is easy to lose motivation and commitment part way through and that will only damage your chances of setting up an emergency fund that lasts, and it may even affect your progress towards attaining financial independence in the long run.

Regular Contributions

With this approach you will set a certain amount of your leftover money at the end of each month and put that into your emergency fund until the target is hit; usually this amount will be lower than the maximum contribution amount. We actually already covered a brief example of this earlier, with the £100 a month contribution that takes 29 months in total to hit the target.

There’s two ways you can decide on how much each month you contribute on a regular basis:

  1. Just decide on an amount that you want to contribute each month

  2. Decide on the number of months that you want to hit the target in

In either decision you will then need to do some calculations to see if it works for you based on the time you stay exposed to a financial emergency and also the amount of spending flexibility you can maintain during the building process.

Let's take a look at two examples to see how each decision might play out.

In the first example you might decide to contribute a regular amount of £400 each month into the emergency fund. This comes out of your £1,635 leftover money leaving you with £1,235 that you could flexibly spend on other things.

With a target of £2,900 and monthly contributions of £400 the emergency fund will take 8 months to build up. Here are the calculations:

Target emergency fund value: £2,900

Monthly Contribution: £400

Spending Flexibility: £1,235

(£1,635 - £400)

Number of months to hit target: 8

(£2,900 ÷ £400)

Arguably you could say that this approach can be easily reduced to 7 months if you just increase the penultimate contribution a little. But when sticking strictly to the contribution plan it takes 8 months in total to hit the target.

If you’re wondering how I decided on £400 in the first place, I just picked a number that felt sensible based on the information available to me. I know that £100 a month is not enough based on the example we covered earlier and £1,635 is too much based on the maximum contribution approach.

8 months to hit the target is not bad compared to the 29 months it would take when contributing just £100 a month, but if you really wanted to you could do a bit better.

In the second example you might take what you’ve just learnt from choosing £400 as the contribution amount and decide that it would be better to hit your target in 6 months rather than 8 months.

You’re basically trying to strike a balance between speed and contribution amount, and you feel that you can still put a little bit more in each month if it means reducing your risk and exposure to a financial emergency.

To hit the target in 6 months you can simply divide the emergency fund target value by the number of months to calculate how much you would need to contribute each month. Here are the calculations:

Target emergency fund value: £2,900

Months to hit target: 6

Monthly contribution to hit target: £483.34

(£2,900 ÷ 6)

Spending Flexibility: £1,151.66

(£1,635 - £483.34)

As you can see, it doesn’t take much more in monthly contributions to reduce the time to hit your emergency fund target by 2 months, and you still have over a £1,000 leftover from your income to spend on whatever you wanted. This is well worth considering when you are going through your own calculations, taking into account all of the information available to you and using your own knowledge of your personal situation.

The benefit of making regular contributions is the amount of spending flexibility you have in terms of your leftover money. You get to work with the numbers and find a balance between speed and flexibility that works for yourself. This ensures that you have some leeway to spend some of your money on the fun things so that it doesn't feel like you're missing out on living your life, while still building up an emergency fund to protect yourself from any financial emergencies.

It might make the building process a little bit longer but that spending flexibility might be the key to keeping you motivated and focused on your long term goals of financial independence.

The drawback will obviously be the reduced amount of speed to hit your emergency fund target. Disaster could strike at any moment and there'll always be a window of exposure that you cannot fully avoid. However, the bigger you leave that window the more exposed you are and that is always a negative. The risks of a financial emergency always seem really far away and unlikely, until they actually happen and become the biggest problem in your life at that specific moment.

Optimised Contributions

If you’re a bit like me you might be wondering if there’s a way to have both speed and flexibility at the same time. There will always be a trade off between the two, but that doesn’t mean you can’t try to find a balance that you feel is optimised for your situation and personal preferences.

This approach attempts to help you find that balance by using the information you gathered in the other approaches. Don’t worry, it’s not actually that complicated or technical. There’s two methods in which you can do this:

  1. Go for something in between your maximised contribution and regular contributions.

  2. Use the fastest speed known and figure out if it’s possible to introduce some flexibility.

I’ll work through an example for each method.

With the first method it’s actually just the same as figuring out regular contributions, but you will improve on your results by using more of the information that is now available to you. You know from the maximised contributions approach that the fastest time you can hit the target is 2 months, and you know from the regular contributions approach that you have a good amount of spending flexibility with contributions that allow you to hit the target in 6 months.

So just choose something in the middle, such as 4 months and see if that works for you. Here are the calculations:

Target emergency fund value: £2,900

Months to hit target: 4

Monthly contribution to hit target: £725

(£2,900 ÷ 4)

Spending Flexibility: £910

(£1,635 - £725)

By setting a target of 4 months you would need to contribute £725 each month to your emergency fund. That leaves you with £910 (from £1,635) to spend flexibly. Depending on what you like to spend your money on you can now decide if this set up works for you.

With the second method you will use the knowledge that it takes 2 months to hit your target with maximum contributions. The challenge is to figure out if it’s possible to meet this timeline while still having a sensible amount spending flexibility.

To do this you divide the emergency fund target value by the number of months you are aiming for, and then you subtract that result from your leftover money (£1,635) to see what that leaves you with in terms of spending flexibility. Here are the calculations:

Target emergency fund value: £2,900

Months to hit target: 2

Monthly contribution to hit target: £1,450

(£2,900 ÷ 2)

Spending Flexibility: £185

(£1,635 - £1,450)

So what you’ve established here is that it is possible to hit the emergency fund target in the fastest possible time while still having some spending flexibility each month throughout the building process. You will then need to decide if that amount of spending flexibility is enough for you to feel like it is worth taking on this approach with these levels of contributions.

To Conclude

For me, if I can hit my emergency fund target really quickly and still have a little bit leftover each month to spend flexibly then I would probably think it’ll be worth it, even if that amount is quite small in comparison to the months with normal budgeting. This is because I would come to the conclusion that once I’ve hit the target I will have peace of mind on my ability to handle a financial emergency, and that will allow me to focus better on the other aspects of my journey towards financial independence.

Ultimately the choice would be yours to make and if an optimised contribution approach takes things a little bit too far, then it’s not a problem for you to settle on another approach that might take a little bit longer but provide more spending flexibility. The most important thing is that you have started working on your emergency fund.

Now that you know "how to start" building your emergency fund it'll be worth thinking about how you continue building it up and at what point should you stop. Let's cover that in the next article.

Read the follow up article on building your emergency fund. Check it out here.


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