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How much emergency cash should we each hold?

Barely two years have passed and already I’m asking this question again – only this time, the trigger is not pandemic-related job insecurities but the cost-of-living crisis that is biting hard on disposable incomes.

It’s not the only thing worth pondering either because if higher inflation sticks around, we may also have to reassess whether our current financial planning will be enough to cover future outgoings or, even, whether it could potentially delay our goals, including retirement.

The price of everything seems to be going up, made worse by the conflict in Ukraine that is amplifying the general uncertainty and squeezing the supply of oil, other raw materials and basic foods. The latest set of official data shows real wages in the UK suffered their biggest quarterly drop in almost eight years1 – and that’s only up to the end of January, before next month's expected 54% jump in our electricity and gas bills2.

The Office for Budget Responsibility, which watches over the government’s finances, predicts that average disposable incomes in the UK will see the biggest decline over the next year since at least the mid-1950s3.

So how should we adapt? How much ‘rainy day’ money do we need? These are key questions because, much like clearing your credit card debts, making sure you have enough money for an emergency is something we should all do before we invest our money.

Even if you can easily absorb the current rise in the cost of living, it’s food for thought for the future, when you’ll be more reliant on your savings. How realistic are your expectations of what you’ll need when you retire? Is your pension planning still adequate?

More means more

The short answer is that most of us may now need a bit more contingency money than we used to. How much exactly will be shaped, in part, by your general attitude to risk but should always be tied to your financial circumstances (and to those of your partner and/or family).

For example, if you have reason to worry about your job prospects, it’s probably good reason to consider putting a bit more emergency cash aside. The same would be true if you have a big mortgage and are worried about interest rates going up or are concerned about a family member’s health and ongoing capacity to work.

In general, a good rule of thumb is to have a cash buffer that at least covers three months of your outgoings – to tide you over until you’re able to get back on your feet. And since these outgoings have gone up in price, it stands to reason that you now probably need to set aside more than you used to.

So consider whether your existing cash buffers are big enough and whether you need to build them up. Just remember, though, that keeping too much of your savings in cash will leave them at the mercy of inflation. So once you are satisfied that you have enough rainy-day cash, consider investing these surplus savings in shares and bonds. Our research has found that shares have been relatively reliable generators of real (inflation-adjusted) returns over the long term.

Cutting costs

Don’t throw money away needlessly either. Check that you don’t have direct debits going out that are unnecessary – these things can creep up on us.

My years in financial planning tell me that people don’t cut costs as much as they should do when faced with sudden circumstantial change. Given the energy price shock we’re all facing it might also be worth exploring what you can claim back from HMRC if you have at all worked from home – as well as trying to find other ways to trim your outgoings.

It’s your personal choice, but every little helps.

Another thing you can do to save money is to cut your investment costs. After all, your goals probably haven’t changed, despite everything that’s happening in the world. You still want to buy that house or car or fund that wedding or retirement, so you still have good reason to continue investing.

Reducing the annual cost of your individual savings account (ISA) or private pension by 1%, for example, would mean a saving of £400 on a portfolio of £40,000. It wouldn’t be a one-off saving either, as it would compound each year along with your investments. In back-of-the-envelope terms, that £400 saving per year growing at a hypothetical average annual return of 5%, say, would be worth almost £5,700 over 10 years.

And if your portfolio is even bigger, so are the cost savings, naturally.

Now may also be a good time to reassess your financial planning by considering what your future outgoings might be and setting realistic expectations about the returns you are likely to earn from your investments.

Putting all this together, are you still on target to fund the kind of retirement you want for yourself? Should you be upping your pension contributions?

Focus on your goals, and on what you can control. and you’ll improve your chances of investment success in the long run.


1 After adjusting for inflation, the Office for National Statistics (ONS) said regular pay in the November-January period fell by 1.0% compared with a year earlier. Real total pay, including bonuses, held up better and grew by 0.1%. Average weekly earnings in Great Britain, ONS, 15 March 2022.

2 Price cap to increase by £693 in April, Ofgem, 3 February 2022.

3 Economic and fiscal outlook, 22 March 2022

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