Where should you be keeping your emergency fund?

Investing is a smart way to build your wealth, and having an emergency fund is essential to not lose what you already have. Before you start your investment journey, it’s smart to build up an emergency fund that you can use when life comes at you with an unexpected twist.

An emergency fund is usually a pot of cash that amounts to between three and six months worth of expenses that you build up, separate to your investments. This gives you the room to get back on your feet if something unexpected, like a redundancy or a car issue, arises. Think of the money as your own insurance policy.

This money is kept in a separate cash account, instead of being invested, so you can use it as soon as you need to, rather than catching the markets at a bad time when you need to withdraw or having to wait a set period of time before the money reaches your account. But what many people do not know is that not all cash accounts are created equal, and in trying to find a good deal, you could end up unexpectedly locking up your savings.

There are three main savings account options to choose from: an easy access account, a fixed-term savings account, and a notice account.

Fixed term and notice accounts typically offer a slightly better rate of return, but this is because of the requirements for the account, which are not necessarily compatible with what you need for your emergency savings account.

Fixed term accounts mean that you agree to keep your money in the account for a set amount of time, for example, two years. This could be very problematic for your emergency savings account, because you might not be able to access it when you need it, defeating the purpose.

A notice account doesn’t have a set investment period, but it does have a notice period before you remove your cash, which typically ranges from one to four months. Again, this isn’t a very helpful system for someone who needs cash right away for bills or repair costs.

For most people, losing a few decimal points worth of interest isn’t worth the stress when it comes to their emergency savings, making an easy access account the best option. Through this type of account, you should be able to access your money quickly. The exact time will vary by bank, but they are often instant or by the end of the next working day. You can still shop around for the most competitive rates with this type of account through the Cash savings hub.

Some people may also just choose to use the savings account option offered by whoever they hold a checking account with. These banks often offer instant transfers between the two, taking away the lag time completely.

Note that any of these accounts could be subject to income tax if they are not in a Cash ISA and exceed your tax-free allowances. Basic-rate taxpayers have a savings allowance of £1,000 each year, while higher-rate taxpayers get £500 and additional-rate taxpayers have no allowance. Are you paying more than your fair share of income tax?

Can you use a credit card in the meantime?

Some investors may be tempted to just rely on a credit card for any immediate emergency expenses and then use emergency savings from a locked account when they are able to access it. This is generally not a good idea. If for some reason that credit card debt could not be paid off in time, you could quickly face painful rates of interest in the range of 30%.

Usually, when an incident occurs where we need to use an emergency account, we’re feeling stressed enough. Emergency accounts not only provide financial security but help us sleep easier at night. Keeping the money somewhere that’s easily accessible, and where you know exactly how much will be there, is some much-need assurance during a stressful time.