Stay safe with a contingency fund
Start saving now Protect your Household Build contingency fund
To quote Oscar Wilde “To expect the unexpected shows a thoroughly modern intellect”. It is just such an approach which underlies one of the most important maxims in personal finance: build a contingency fund.
Having such a back-up fund means individuals and their households have a financial cushion to meet the unexpected. Covid-19 is just such an event: the number of people applying for Universal Credit has increased 10-fold. Even employees who are being furloughed will see a 20 percent drop in income. For the self-employed and Directors of limited companies the financial hit is more immediate and more extreme. But for all households who see a temporary drop in income, those without liquidity in the family finances, face real and pressing problems.
While acknowledging that Government is offering help and also that banks and other lenders are providing payment holidays, at some point these bills and debts will have to be paid. Failure or a delay in doing this will lead to adverse credit scores, financial hardship and possibly the re-possession of any secured assets. In addition, there will be a general increase in household stress around money.
But human agency, that is the capacity for us to influence our environments and our futures, also has an important role to play. Those who have built up a contingency fund have a bit of breathing space; others will be making rapid adjustments to household spending.
How much of a contingency fund should a household aim for? To start with the answer is pretty simple – anything is better than nothing. A longer-term answer would be between three and six months of regular spending. This begs another question household members might ask themselves - what is our regular spending? This in turn might lead a household to examine their regular outgoings and discuss what is essential and what is discretionary spending.
Questions might include “what have we been doing with our money and have these purchases really been worth it?” While the occasional meal out/ cinema trip/ home delivery should quite properly be enjoyed it is likely many people spend on what they might decide, when pushed, are “non-essential” purchases. I won’t list them as each individual and household have their own priorities. An important first step is for households to track patterns expenditure. They could then set themselves goals, such as “decrease our spending by 10%” or “identify 2 categories of spending we will cut out”.
This process will bring household cash flows into balance and allow them to build up a monthly surplus which can kick-start the contingency fund.
Where should households put this money? As liquidity is a priority easy access savings accounts are an option. Another possibility is Premium Bonds, where the money is saved with National Savings and Investment and where there is a (small) chance of winning a prize, a situation which Andy Hart from Maven Money has described as playing the lottery but getting your stake money back. Given low interest rates the real return on these savings is not financial but peace of mind.
The present Covid-19 pandemic, for all the problems it is causing, does offer a useful signpost to the importance of building and keeping a contingency fund. As Warren Buffet comments, “Do not save what is left after spending; instead spend what is left after saving.”
Dr George Callaghan,