Three years after the coronavirus pandemic, the economic fallout from lost working hours and government borrowing remains. As worldwide economies battle soaring inflation the war in Ukraine has exacerbated market volatility and kept energy prices high.
Uncertainty in global markets, high inflation, and stark historic lessons about the speed with which the unexpected can strike, mean that now is the ideal time to check in with your emergency fund.
Protecting yourself against the unforeseen is a key part of your financial plan. That might mean making sure that you have enough put aside for an emergency, but also, that you don’t hold too much.
The cost of living crisis continues to cause huge increases in household bills
The most recent figures from the Office for National Statistics (ONS) confirm that inflation is falling. The Consumer Prices Index (CPI) dropped to 8.7% for the year to April 2023.
While this is good news for consumers, it’s important to remember that a fall in inflation doesn’t mean a drop in prices, only that prices are rising less quickly.
Source: ONS
The Bank of England (BoE) doesn’t expect the CPI to return to its 2% target until the end of 2024. The central bank also expects to make further rises to its base rate in the coming months.
Increases to the base rate are a tool the BoE uses to control inflation. A higher rate increases the cost of borrowing so that consumers opt to save more and spend less. This reduces demand for goods and services and so should be deflationary.
The rise of inflation since the end of Covid restrictions (both in the UK and across the world) has proven hard to combat, however.
This has led to the BoE increasing the base rate at 12 consecutive meetings of its Monetary Policy Committee (MPC). Since December 2021 it has increased from 0.1% to 4.5%.
Inflation at 2% is still some way off and in the meantime, the cost of living crisis continues.
A recent Royal London report has found that the average UK household bill increased by £441 a month in the 12 months to February 2023. Households with pets or children (or both) fared even worse.
Focusing on your long-term goals is key during uncertain times, but so too is protecting yourself from further financial shocks. You can do this through careful management of your emergency fund.
High inflation and rising interest rates might require a financial juggling act
Your emergency – or rainy day – fund should ideally cover between three to six months of your household’s living expenses. This should cover your day-to-day expenses if an accident or illness strikes, or help towards unexpected costs like sudden household repairs
You’ll also need to ensure the money is held in cash so you can access it quickly when you need it.
A high-inflation economy makes managing your emergency fund harder than usual. That’s because the interest rate on your easy access savings account – even after accounting for recent base rate rises – is likely to be lower than inflation. This reduces the buying power of your cash.
In other words, your emergency fund is effectively losing value in real terms.
You’ll need to think carefully about the value of your cash savings and balance your need for a rainy day fund with the potential benefits of holding your cash elsewhere.
Investments could offer the chance for inflation-beating returns
If you have cash that exceeds your optimum rainy day fund, investing this excess might be a good option.
Investing your money gives you the chance of achieving returns that match or even beat inflation, but there are risks attached. The value of your invested fund can fall as well as rise and you could end up with less money than you put in.
You’ll need to be very clear about your investment goals, which should ideally be at least 5 or 10 years away. Your goal is important because you’ll need to focus on this when short-term volatility strikes. Downturns in the market might make you nervous about your investment but staying unemotional and avoiding kneejerk reactions is key.
Also, be sure that you understand your attitude to risk and capacity for loss. These can change over time and aren’t set in stone so you’ll need to revisit your investment strategy if your goals or priorities change.
Get in touch
An emergency fund is key to ensuring and maintaining your financial security. But in the current climate of high inflation and low savings rates, holding too much in cash could see the value of that cash eroded in real terms.
If you would like help with managing your rainy day fund, or you want to look into investment alternatives for your excess cash, get in touch now. Please email hello@globeifa.co.uk or call us on 020 8891 0711 to discuss how Globe IFA’s expert financial advisors can help you.
Please note
The value of your investments (and any income from them) can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance. Investments should be considered over the longer term and should fit in with your overall attitude to risk and financial circumstances.
