Prepare for disaster: do you have a financial safety net?

Colleges week

Two thirds of British families have no financial safety net at all. They're perfectly fine as long as the boiler keeps working, the car doesn't break down, nobody gets ill, and the taxman never makes a mistake. But what are the chances of that happening? With so many millions of people just one unexpected expense away from financial disaster, we all need a safety net in place.

And building one doesn't have to be as difficult as it seems.
Work out what you need
The kind of disaster that requires a safety net comes in two forms: the first is a one-off expense, and the second is something like illness or unemployment which wipes out your income for a period.

Your first goal should be to save enough to cover one-offs, like the car or boiler repairs, which require anything up to £1,000. However, after you have saved this, you need to keep going until you are covered for the more expensive eventualities.

You need to consider roughly how long it will take you to get back on your feet in the event of illness or redundancy. It's not an exact science, but think about things like how easy it is to find a job in your profession, what health risks you face, and whether you have any insurance products that would pay out for a serious illness after a specific period. Some experts say you should have enough set aside to last you for six months. However, three months is a useful first goal.

Then use a budget calculator to work out how much you spend on essentials each month. This is just those things like paying the mortgage and being able to afford energy bills - so leave out any kind of a social life and any discretionary spending. This will tell you the total sum you need to build.

Make the savings
Most people will tell you that they don't have a penny spare in their budget for saving, so simply putting money aside into a separate savings account is going to start causing them cash-flow problems.

It means that before you start saving you need to revisit your budget and work out how you can carve out a reasonable sum to be saving every week. Look at everything you spend money on - from energy to baked beans - and consider whether you could find a cheaper option. It's also worth looking out for money you are wasting on things you don't take advantage of, like monthly subscriptions. Only once you have done the easy things should you consider sacrifices like taking lunch to work and replacing nights out at the pub for an evening in the garden - at least until you have a safety net.

Once you have worked out what you can afford, by far the simplest way to put money aside regularly is to set up a standing order to come out of your account every month on the day after you are paid. That way it will leave your account before you have a chance to factor it into your monthly spending.

Think carefully about where you want to save the money too, and what will suit your needs. At least some of it will need to be available instantly, and you'll need it somewhere where there are no restrictions on withdrawals. It's up to you whether you think you can put some of it in a more restricted account with a higher interest - such as a regular savings account. So consider your needs and find a savings account to match them - rather than doing it the other way around.

Keep an eye on it
You will need to keep an eye on the interest rate offered by the savings account you choose. If there's a bonus on the account, you will need to make a note to shop around when the bonus expires. In any case, it makes sense to revisit this on a regular basis as the market changes frequently.

You will also need to make a date each year to review your safety net. You might think that once you have set aside three months' of expenses, you are covered for every scenario. However, if your essential expenses go up, your safety net will need to increase in order to match them.

While your safety net shouldn't be out of sight and out of mind, this isn't an excuse to dip into it. It's tempting to think you can use it for short-term expenses - like a holiday - on the promise that you'll build it up again before you need it. However, the nature of an unexpected expense is that you never know when it's going to strike. You need to keep this fund for emergencies only - or you run the risk of blowing it on a week in Spain, and then coming home to find yourself out of work.

The exceptions
As a rough rule of thumb, everyone should be working on a safety net, but there are exceptions. If you have debts with high interest rates, paying these off should be your top priority. There's no point having thousands of pounds in the bank if you're also borrowing and paying handsomely for the privilege. In this instance you should go through the same process in order to free up cash in your budget, then spend that paying the debt down before you start building the safety net.

While you are left without a net, it's also worth getting a credit card for these emergencies. You need to have the discipline not to use it for anything else, but you should have one in your wallet in case of emergencies - which will save you falling back on a more expensive form of emergency debt.
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