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Inflation and your emergency fund – what it means for your savings

With inflation running at a 30-year high, we take a closer look at what this means for your emergency savings and what savers can do.

Important notes

This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

With inflation running at a 30-year high, our incomes are stretched tighter than ever. To make matters worse, the cost of some of the essentials is rising even faster. It not only makes it incredibly difficult to cut our costs and make ends meet, it also means we need to rethink our emergency savings.

This article has information to help you make the most of your money. But it isn’t personal advice. If you’re not sure if something’s right for you, ask for financial advice.

The impact of inflation

Inflation hit 5.4% in December, and the essentials saw some of the steepest rises – with electricity up 18.8% in a year, gas 28.8%, and petrol 27.8%. Meanwhile food is up 4.5% in a year.

Rapid rises in essentials should ring alarm bells. While we can cut back on the little luxuries in life to make ends meet, there’s far less we can do about the cost of items we can’t live without. Once we’ve shopped around for better deals and traded down on brands, we’re left with some incredibly difficult decisions.

It means more people risk borrowing to cover these costs, and running up expensive debts on top of everything else. In November, we borrowed more than we had done a year earlier – this was the first time we’ve seen this happen since the onset of the pandemic. And while it coincided with a burst of Christmas shopping, there’s also the risk some people were borrowing to make ends meet.

Over the next few months, inflation is expected to rise to at least 6% overall – and possibly to as much as 7%. And the weight of these price rises will again fall on the essentials – including energy bills. It was announced today that the energy price cap will increase by £693 from 1 April.

At the same time, we have looming tax hikes to contend with, including the planned National Insurance rise in April. It means we’re not just stretching the same money further, we’re having to work miracles with a smaller pay packet.

What does this mean for our emergency funds?

Not only do price rises risk essential costs swamping our budgets, they also raise questions about our emergency funds.

While we’re still working, we should have emergency savings to cover at least three to six months’ worth of essential expenses. When we’re retired, that rises to one to three years’ worth. So with these expenses on the rise, we need to boost our savings too.

The right sum for an emergency savings safety net differs wildly from one person to the next. It depends partly on what you spend. It also varies with our circumstances – ranging from how secure our income is to how good our health is and who else relies on us to keep a roof over their heads.

There’s also a difference in what different people consider essential. However, it can be useful to look at some of the typical figures to give us an idea of the changes we might need to make.

The HL Savings and Resilience Barometer shows that on average, we spend £20,859 on essentials every year – with the lowest fifth of earners spending an average of £6,937 on the basics, and the highest fifth spending £35,764.

For the average person in the UK, that means three months’ worth of essentials costs £5,215, six months’ worth is £10,430, a year’s worth is £20,859, and three years’ worth is £62,577. Of course, the average covers an enormous range. So the only way to work out what it means for you is to actually calculate what you spend on the things you couldn’t live without.

When inflation’s on the rise, we need to keep going back to our figures. If, for example, your emergency fund is £5,215 and the cost of your essentials rose 5.4%, then you’re likely to need to boost your savings by another £282. And if your fund was £20,859, you’d need to work on finding another £1,126.

Of course, with inflation stretching your budget, it’s an even bigger challenge to find the extra cash to put away for emergencies. For some people it will simply feel like a step too far. Especially if they have already shopped around for the best possible deals, cut out the luxuries they weren’t getting enough value from, and cut back on those luxuries they really appreciate.

However, it’s always worth going back to the budget to see if it can be squeezed even harder. But also whether there are any lifestyle changes to be made in the short term, to protect ourselves in the long run.

Find out more on how to become financially resilient

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