How much cash should you hold?
Everyone needs cash savings
Important - Active Savings helps you make your own decisions and, like this guide, is not personal advice. Seek advice if you're not sure what's right for you. Fixed term products generally only allow access to funds at maturity. Inflation reduces the future spending power of money.
It’s important for all of us to have a safety net to fall back on when the unexpected happens.
But we’re all different. That means the exact amount of money you should keep tucked away will depend on your circumstances and your lifestyle.
This guide looks at how much cash people should consider holding and where they should think about keeping it. It isn’t personal advice based on your circumstances, it’s helpful information to help you plan. If you’re not sure what’s right for you take advice.
Why should you hold cash?
Two in five people had a surprise cost in the last year.
Cash is predictable, reliable and boring. That’s exactly how it should be. It should sit there ready for when you need it and ready to help you out when things get tough.
It’s not just the risk of needing money quickly. Truth is, even if you have a steady income, you should always have emergency cash for unexpected expenses.
The problem with unexpected expenses is you can’t predict when they’ll happen, so we have to prepare.
We surveyed 2,000 people from across the country to find out:
- How many have had an unexpected cost in the last year?
- How much did it cost?
- How did they pay for it?
The results reinforced the need for emergency savings.
Two out of five people surveyed faced a surprise cost at some point in the last year – rising to almost half of people aged 18-54.
This ranged from property repairs to car trouble or unexpected bills. The most frequent cost is £501 -£1,000, with around 10% costing more than £3,000.
Have you had any expenses out of the blue in the last year?
Value of unexpected costs
Fortunately, most people paid for these costs with savings.
But worryingly, many people put some of it on a credit card, borrowed from family and friends or dipped into their overdraft.
Your emergency fund is your priority.
Borrowing from family isn’t always an option, while falling into debt can mean racking up interest charges while you pay it back. There’s also the chance of another expense coming up before you’ve paid off the last – making problems worse.
Your emergency fund is your priority. You should build this up as soon as possible, before you consider investing. The exception to this is your workplace pension, where it normally makes sense to contribute at the same time.
The goal is to have enough savings to cover unexpected costs, even if they come in quick succession.
Of course, not all of your spending will come out of the blue.
Many of us will have plans of a big-ticket purchase or expenditure on the horizon. If you can’t cover the cost from your income, you’ll need to have savings set aside.
Some of us like to have different savings pots for each of these expenses. This can help you keep an eye on progress and stop you from dipping into them. You can include pots for regular annual expenses like holidays, ongoing expenses like property and car maintenance, or one-off expenses like a wedding.
You should always hold savings you need for emergencies in an easy access account. Those you’re holding for expected expenses in the next five years are better off in cash too.
Some people will invest for near-term planned expenses, especially when starting from scratch or keen to build their pot quickly. This isn’t a good idea for most people. If you’re thinking about taking this approach, it’s essential to understand the risks and have a plan B if investing doesn’t work out.
How much cash do people currently hold?
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How much cash do people currently hold?
A surprise expense can come from anywhere.
Too many people don’t have enough cash savings.
According to a study by the Financial Conduct Authority (FCA), over a third of people in the UK have less than £1,000 in cash. The figure is even higher for younger people. That’s not an enormous surprise given how expensive life can be when you’re starting out, and how low incomes can be.
But an expensive surprise can hit us at any stage and leaves many of us at risk.
Some groups struggle particularly to build up cash savings. Despite often having irregular incomes that would make savings more valuable, self-employed people have lower cash holdings than people who are employed.
Likewise, people who are renting are far less likely to have £1,000 or more in savings – 60% fall short compared to a third of those with a mortgage.
There are even big gaps in savings among people you’d expect to be able to save with ease. Some 16% of people with household income of £70,000 to £100,000, and 13% of those above £100,000 have less than £1,000 in cash.
% of people holding under £1,000 and £10,000 by household income
How much cash should people hold?
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How much cash should people hold?
Consider your expenses instead of income.
Life would be far easier if people knew at a glance exactly what they were aiming for.
Unfortunately, having one exact figure that works for everyone is impossible.
A young person in shared-rental accommodation outside London, with low outgoings, will be able to cope on much less than someone with children in private school, an expensive car lease and a large mortgage.
Monthly income isn’t necessarily a sensible place to start either.
Earning more can lead to spending more, not necessarily on the things you need either. The Institute for Fiscal Studies found wealthier working households spend a greater proportion of their income on non-essentials. In particular, holidays, restaurants, hotels and ‘cultural services’. People could give these up if push came to shove.
It makes far more sense therefore to look at your household expenses. You can then tailor it to your own needs.
Calculating your household expenses
The first step is to work out what you’re actually spending – and what you’re spending it on.
Once you know what you’re spending on various things, you need to decide which of those expenses you want to be covered if you lose your income.
As a starting point, you could split your spending into three columns like we’ve done below.
|Food||Education costs||Gym membership|
|Utility bills & council tax||Clothing||General shopping|
All of us are different. The decision over which expenses to cover will depend on the compromises you’re prepared to make during tough times. It will also depend on the savings target you’re happy to aim for.
Most people should aim for a minimum of three to six months’ worth of expenses when you’re working and one to three years of expenses when retired - far more than many of us currently have.
Proportion of 'average households' spending
How much cash to hold when you’re working
The general rule of thumb is anyone of working age should have a minimum of three to six months’ worth of expenses in savings for emergencies.
The reason for choosing three to six months is that it can take this long to put together a plan B if you lose your income. You’ll have breathing space to find work or adjust your lifestyle permanently to manage on a lower income.
Each person’s experience of losing work is different. It’s more difficult to find employment in some industries or roles. And we know it gets harder to find employment as you get older.
Currently one in five unemployed people have been without work for more than a year. For the over 55s it’s one in three.
If you think you’ll find it harder to get a new job, hold more savings.
So how much could it be? To help, we’ve used the ONS data (released 6 April 2020) to estimate the average household expenditure for essential, comfortable and non-essential spending for people still working.
Average household expenditure (pre-retirement)
|3 months||6 months|
|One adult||Two adults||One adult||Two adults|
How much cash to hold when you’re retired
A large savings pot is vital in retirement. You should consider 1 to 3 years’ worth of expenses.
Once you’re living on a lower fixed income, you have less flexibility to meet unexpected costs, so you need more savings to fall back on. It’s also more difficult to rebuild a savings pot quickly. A larger savings pot is vital to give you extra flexibility.
If you’re taking an income from your pension, you may also need to vary the amount you’re taking to match the investment environment. You could need to turn to your savings for income for a number of months if the stock market falls in value or you don’t get the dividends or income you were expecting.
Your lifestyle’s also less predictable in retirement. While in work, you tend to have the same spending patterns for most of the year. In retirement, you could spend vastly different amounts depending on whether you’re at home or travelling the world. Cash savings give you more freedom to vary your spending accordingly.
Again, to help we’ve used ONS data (released 6 April 2020) to estimate the average household expenditure into essential, comfortable and non-essential spending for people in retirement.
One to three years of expenses may seem broad. But a lot depends on your circumstances and where your income is coming from in retirement. If all your spending is covered by the state pension, Defined Benefit (DB) pension scheme or an annuity, you may only need to hold one year of expenses. If all your income is coming from your investments, then you may want a larger buffer in case of sudden drop in the market or investment income.
Average household expenditure (in retirement)
|1 year||3 years|
|One adult||Two adults||One adult||Two adults|
Finessing your figure
Once you know the number of months or years’ worth of expenses you want to cover, and the costs you want to include, you’d have thought you’d know your savings target.
Life isn’t that simple.
Your job will make a difference. Being employed means you can rely more on a steady income than someone working for themselves, who may need to hold more cash to cover quiet periods – alongside the cash they’re holding to pay their tax bill and any cash held in the business (if they run a limited company).
Even among those who are employed there’s an enormous variation. Some will have fluctuating incomes because of their contracts, bonus, commission or overtime. They’ll need to be confident their savings buffer will get them through the leaner months.
It’s also worth considering how secure your job is. This can come down to if you’re temporary or permanent, or whether the sector you work in is vulnerable to a downturn.
Your own ability to work will play a part too. If you’re in poor health or have family responsibilities, your income could be more precarious and mean you’ll need a bigger savings buffer.
Given the variety in working patterns across people’s lives, it makes sense to look at what stage of life you’re at, not your age.
When you’re starting out, it’s going to be more difficult to build up a safety net. Your income is lower and outgoings are onerous. But you still need to be saving whatever you can afford as soon as you can afford to do so.
If the savings target seems offputtingly large, it can help to aim for 3 months of the essentials. Once you have that, start tailoring it more to your needs.
Our families may play a role in our decision-making too. If your family can step in when things get difficult, that can act as a plan B beyond your emergency savings. If not, you’ll need to be able to cope financially without help. Later in life, if you have a family of your own, you may also need to factor in them coming to you for help, and your savings should reflect that.
Retirement has a big impact on your approach to emergency savings. We naturally get more wary about risk as we get older - and rightly so. Once you’ve stopped work, it may be difficult to start earning again, so you’ll want to have enough savings so you don’t run into difficulties.
You also need to think long term about your savings. It’s not a pot to build up, use and then build again. In many cases, retirement incomes aren’t much higher than your expenses. So you need to be confident you can cover expenses out of the blue throughout your retirement.
If you’re taking an income from drawdown, you’ll need even more cash to hand. This will give you the ability to reduce payments or pause them completely in poor market conditions. In our opinion, anyone in drawdown should err on the side of caution having the full three years’ worth of expenses.
What should you do with your cash?
What should you do with your cash?
People in the UK hold the vast majority of their cash in instant access accounts with high street banking giants.
A significant number of people will also hold their savings with the same bank as their current account - even if that means they don’t get a good rate. One in five aren’t planning to switch because they feel it’s too much hassle.
Your savings shouldn’t be an afterthought, stuck wherever is easiest for us to reach.
It’s worth spending some time considering the right home for each part of our savings.
Your emergency money
There’s no point going to all the trouble of building a savings safety net, if you can’t get hold of it when you need it.
Anyone saving three to six months’ worth of expenses in an emergency fund should consider holding it all in a competitive easy access account. This can be an easy or instant access savings account, a cash ISA or Premium Bonds.
It’s vital to shop around for the best rates when choosing an easy access account.
Most of the major high street banks are currently offering 0.01% on easy-access savings. You are likely to get better rates from newer banks, online players, and building societies.
It can feel uncomfortable saving with a less well-known name, but they’re normally covered by all the same regulations as traditional banks, and the first £85,000 of eligible deposits held with each institution should be 100% protected in the same way though the Financial Services Compensation Scheme, providing it doesn’t share a banking licence with another bank.
Deciding whether a cash ISA or a savings account is right for you will depend on two things:
- If you’re already using an ISA for investment
- Whether competitive cash ISAs offer the opportunity to dip in and top up – which is a requisite for an emergency fund
For basic-rate taxpayers, the current tax-free income allowance on savings interest of £1,000, will mean many emergency funds won’t be big enough for tax to be a concern. But if you’re a higher or additional-rate tax payer this figure drops to £500 and zero respectively. It’s also worth highlighting that for Scottish taxpayers the savings allowance is based on the rest of the UK’s tax bands. Remember, tax rules change and benefits depend on individual circumstances.
Some people like to keep cash in Premium Bonds. The downside is that there’s no interest on these bonds, so unless you win enough prizes, you’ll lose money after inflation. In the average month, the average saver will win nothing, so odds are you’ll end up gaining nothing.
Money you plan to use in the next 5 years
Not all your cash should be sitting in easy access accounts.
You may feel more comfortable with large amounts available at a moment’s notice. But not when you consider the value you may be losing after inflation.
If you’re holding cash for known future expenses, you have the opportunity to tie it up for a period in return for a fixed, higher level of interest. There are a range of products available letting you fix for between three months and seven years. The trade-off for a higher rate is that you can’t usually access your money until the product matures.
Another development has been the emergence of savings marketplaces, such as HL Active Savings. With one account, you can hold money in different products with various different banks together in one place. They also enable you to open new accounts or switch very easily between them without having to fill out any new application forms. It makes it far easier to manage and keep track of your savings.
Saving for the future
Investing gives you a better chance to grow your money in the long term.
Once you’re putting money away for 5-10 years or more, cash isn’t always the best option. Inflation is the general rise in prices of the stuff we pay for every day. The cash we have today won’t have the same buying power tomorrow. Over time, this effect really adds up.
Investing can give you a better chance of growing your money over the long term and, importantly, keeping up with or beating inflation. But it’s important to make sure you have your emergency cash in place before you consider investing. Although there are exceptions to this rule.
Unlike cash, investments can go down in value and you could get back less than you put in. For some people that’s a risk they don’t want to, or can’t take. This could be because they need the money for something specific and have no other way of paying for it, if they don’t meet their targets.
If you invest over a short period, for example less than 5 years, there’s more chance that a stock market fall could derail your plans.
There will also be investors with cash in their investment portfolio. This is normal. But it’s not a long term investment plan. Cash has specific roles in various savings pots for identifiable reasons. It shouldn’t be floating around in an investment account for years because you’re not sure what to do with it.
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