It might seem an odd time to question the wisdom of what seems like a sensible piece of financial advice.
The emergency cash fund is a recommendation that almost all advisers make, as the first thing to do with spare cash after paying off debts.
And in the light of events since February this year, it appears more sensible than ever. But the question is, how much is enough? Three to six months’ salary is the usual rule.
It’s worth remembering that few of us will conform to the averages that such blanket principles are based on – in terms of our careers, financial objectives, attitudes to risk and so on.
‘Some people will prefer, instead of building up a massive cash allocation, to do other things: pay down the mortgage perhaps, or do up the property in order to sell, or invest it, or raise pension contributions.’
Most households either can’t afford financial advice or don’t want to pay for it, and many absorb stock wisdom from the press, which will always tend towards the belt-and-braces conservative.
I think there is room for pragmatism. Let’s say you have a total annual household income of £80,000 – so c.£50,000 net of tax.
Assuming you are able to put as much as £25,000 aside, do you really want it sat in a savings account? Which at the very best will be just protecting it from inflation – and soon probably not even that.
If you then want to buy a home, are you really going to keep that where it is, depreciating, rather than use it towards your deposit or moving expenses?
It has always just seemed a little pie-in-the-sky to me. What is an emergency cash fund for, after all?
Unforeseen expenses like a new boiler it is often said. For most homes that’s c. £3,000 fitted. Yes your roof might fall in too – but it is hoped insurance would cover that.
‘Savings account is increasingly a misnomer, they are largely wasting accounts.’
Most households with half-decent credit ratings can snap up a 0 per cent interest credit card in minutes. Assuming you are comfortable with debt and the repayments, this must be an alternative way to cover unforeseen expenses.
At the worst, the cash fund is a stop-gap for your mortgage and other living expenses should you lose your job and fall ill. But for the life-changing threats of joblessness or ill health you might decide that some sort of income protection or critical illness cover is more appropriate.
Some employees are lucky enough to have such policies as part of their perks package. If you are paying (or not) for this sort of insurance, do you still need a £25,000 emergency fund?
Some people will prefer, instead of building up a massive cash allocation, to do other things: pay down the mortgage perhaps, or do up the property in order to sell, or invest it, or raise pension contributions.
Others will want the security and comfort of keeping that cash in the bank, and that’s fine. We all want some cash deposits to dip into. But some will be happier with a smaller amount than others.
Attitude to risk is one of the things that broach the gap between savings and investing. But the gap need not be so wide, nor the attitude so different.
Savings account is increasingly a misnomer, they are largely wasting accounts.
Inflation is now at 1 per cent and by most reckonings on the up. The best savings account is NS&I’s Income Bonds at 1.15 per cent. For the moment: deposits are flooding in and the rate seems set to fall soon.
So, near-certain losses from saving versus possible losses from investing, where there is also the possibility of positive real returns. I know what I’d choose.
By selecting well balanced and diversified funds – passive or active – or investment trusts it is possible to create a portfolio that is unlikely to suffer major losses even in the short term. The challenge is to keep fees and costs down to the absolute minimum so that returns are not eroded.
But even if your investing Isa earns you a measly 2 or 3 per cent a year, net of fees, that’s better than the alternative. And more fun.