An emergency fund is the least interesting thing on this site and the one that makes everything else work. It is the reason a broken boiler is an inconvenience rather than a debt, and the reason you can leave investments alone when the market falls. The rule of thumb is three to six months of essential outgoings. Here is how to turn that into a number, and what it costs you to hold it.
Essentials, not spending
The figure is months of what you must pay if income stopped: rent or mortgage, council tax, energy, food, insurance, transport to work, minimum debt payments, childcare. Not holidays, not subscriptions, not the gym. For most households the essential figure is noticeably lower than what actually leaves the account each month, and that is the point: an emergency fund buys time to fix a problem, not the lifestyle in the meantime.
On £2,000 a month of essentials, three months is £6,000 and six months is £12,000.
Three or six?
- Nearer three if you have a secure salaried job, a partner with a separate income, no dependants, and cheap access to more borrowing if it came to it.
- Nearer six, or more if you are self-employed, on commission, the only earner, in a sector that lays people off in bad years, or would take a while to find equivalent work. Anyone planning to stop working early wants more still, because the fund is also what stops a market fall becoming a forced sale.
If you are between the two, pick the larger number and stop deliberating. The difference in what it costs you is small, as the next section shows.
What holding cash actually costs
The objection to a big emergency fund is that the money could be earning more invested. True, and smaller than it feels. In an easy-access account at 4.5%, £12,000 earns about £540 a year. For a basic-rate taxpayer on £35,000 the tax on that is £0; at higher rate it is £16. Against a 6.5% expected return from a global fund, the cost of holding the £12,000 in cash rather than shares is roughly £240 a year.
Now the alternative. Without the fund, a £3,000 emergency goes on a credit card at 24%, which costs £720 a year in interest if it is not cleared, and it usually is not cleared quickly, because the emergency is what made the money tight in the first place. The fund is cheap insurance against an expensive event, and unlike insurance you keep the premium.
Holding six months in cash costs about £240 a year in returns forgone. Not holding it costs £720 a year the first time something breaks.
Where it lives
Somewhere you can reach within a day, that pays a real rate, and that is not your current account. An easy-access savings account or a cash ISA is right; a notice account is fine for the second half of a six-month fund; a fixed-rate bond is not, and neither is a fund that can be down 20% on the day you need it. Where to park cash, and what to avoid.
Keep it separate from money with a purpose. A house deposit, next year's tax bill and a holiday fund are all savings, but none of them is the emergency fund, and mixing them is how the emergency fund quietly gets spent.
Getting there
If you are starting from nothing, a month of essentials comes first, before anything else including overpaying debt, because that first month is what stops the next surprise going on the card. Then clear expensive debt. Then build to the full figure by standing order on payday. The order, start to finish, and the automation that gets you there without willpower.
The savings interest calculator shows what the fund earns after tax at your income. The AI Wealth Assistant will tell you whether the buffer or the debt comes first in your case.