I think the definition of “Living within one’s means” is wrong. The Free Dictionary defines it as “To spend less or only as much money as one is earning or is able to pay in order avoid exceeding one’s budget or going into debt“. According to this definition, if you get paid £1,000 a month and spend £1,000 a month, you are living within your means. I think that living within your means should include protecting yourself from any future problems. I am referring to a rainy-day fund.
A rainy-day fund, or emergency fund, is an essential concept for a business. If you run a company without keeping any money set aside, you’re running a real risk of collapse at the slightest wobble. Covid-19 has taught us how sudden and big a financial thunderstorm can come. In 2019 the United Kingdom was enjoying a strong economy, somewhat hindered by uncertainty, but there was no mass redundancies or shops closing and no big bailout funds being paid out by the treasury. Investment platform AJ Bell recently reported that 20 % of UK workers did not have a rainy-day fund and 71 % of workers held savings of up to 3 months salary. This was compared to 5 % of workers who thought having no rainy-day fund was enough and 42 % of workers who thought 3 months was enough. Why do we recognise risk in businesses but not in the home?
Why You Need a Rainy-Day Fund
Since the start of the Covid-19 pandemic, 730,000 fewer people are in paid employment in July 2020, according to the Office for National Statistics. That is 2.2 % lower than July of 2019. There is no such thing as a secure job. Even if you are last on the list to be made redundant, your employer collapsing is nothing you can solve. This is something that can happen at any time. Even before the pandemic, some high-street retailers were shutting their doors. Poundworld was a UK shop that had 355 shops at its peak and they were all closed. This is a risk you need to mitigate against.
Losing your job out of the blue is a stressful experience to go through. Having a bit of financial security behind you eases that stress and gives you the freedom to focus on finding your next job. With a few months worth of living expenses behind your back, you have stability. You can carry on like normal, for example, without having to worry about being evicted if you go behind on rent. Being able to be reliant on yourself will stop you getting trapped in bad debt. Taking out a pay-day loan with extortionate interests rates will keep you in a vicious circle of debt. These predatory forms of credit may be your only place to turn in the event of sudden unemployment without any savings. Large banks are less likely to lend to someone without an income. Having a bit of certainty can allow you be happier and move on with your life. On top of this, you will also have more of your most valuable resource – time. If you can afford to not work for a few months, you can utilise your time in an efficient way, for example, by retraining. This can also put you ahead of the field when returning to the competitive job market. There are lots of free resources online you can use to retrain. Sometimes, you are required to pay for the qualification or certificate. However, unless it is a legal requirement in your field, an employer may just be happy with proof that you took the course and your clear demonstration of your enthusiasm and eagerness to learn.
How and How Much?
To save for a rainy-day fund there is only one answer. Every month, save as much as you can. The higher percentage that you save is what matters, not the absolute monetary value. If you spend 50 % of your income, it will take 1 year to build up a rainy-day fund of 6 months of your salary, and 6 months to save up your 6 month rainy-day fund of your expenditures. To help you calculate how long it would take you to build your fund, I have created a tool below that calculates how long it will take you to create a rainy-day fund. Enter your monthly income, how much you save each month and how big you want your rainy-day fund to be. Remember to make your fund easy to access by storing it in something like an instant access savings account. After that, do not touch it unless in the case of an emergency (not a new jacket or a car).
How much you put in your rainy-day fund is ultimately your decision. You need to weigh up the risk versus reward. If you keep 12 months of your salary in a rainy-day fund, question whether it is likely you will need a fund for 12 months, you could put that money elsewhere and make it grow faster. Generally, 6 months seems to be a low-risk acceptable number that a lot of people recommend, and it’s what I would suggest too.
Rainy-Day Fund Calculator
Percentage of Income Saved:
Size of Salary Rainy-Day Fund (Months):
Size of Expenditure Rainy-Day Fund (Months):
Number of months it will take to save up your salary rainy-day fund:
Number of months it will take to save up your expenditure rainy-day fund:
What is the difference between a salary rainy-day fund and a expenditure rainy-day fund?
A salary rainy-day fund is one that is based on how much you earn. If you earn £1,000 a month, and you want a rainy-day fund for 6 months, it will be worth £6,000. Alternatively, an expenditure rainy-day fund is based off of your monthly expenditure. For example, if you spend £500 a month and you want a fund for 6 months, this will be worth £3,000. If you put your savings somewhere each month, like an investment, and would like to continue doing this in difficult times, it may suit you to choose a salary based rainy-day fund.
Originally, I was quite shocked to see how few people keep a rainy-day fund, but on reflection it’s not fair to point the finger and blame all UK workers. Typically, the more you need a rainy-day fund, the harder it is to make one. Low-paid employment is typically lacking in security and in an economic crash, similar jobs can be difficult to get due to the demand increasing so much that it far outweighing the need. If thousands of people lose their jobs due to a retail giant closing its doors, there is not going to be another retailer round the corner waiting to hire all of them. Even in a good economic climate, low-paid households relying on the majority of the paycheck for basic necessities like rent and bills can find it difficult to build up required funds. If you have 5 % of your paycheck left at the end of each month, it will take you 10 years to build up a rainy-day fund worth 6 months of your salary.
Do you have a rainy-day fund, how big did you make yours and have you ever needed to dip in to it?