how much of a deposit-based emergency fund do I need?

[Ochayebeers]

Hi,

I've been following the site for a few weeks now and although most things are US-centric (I'm Scottish)I've found it quite useful.

I'm not too bad with finances (I'm a trainee financial adviser) but I am interested in what I can learn about budgeting from the site as it's a discipline that isn't really covered by the industry here. We are a little behind the curve in that we are only just getting into the whole life-planning and cashflow modelling thing. We are either sales-driven at the lower end or concerned with wealth management and tax mitigation at the higher end.

One question I would like to put to you is how much of a deposit-based emergency fund do I need based on my situation?(Sorry for the Sterling amounts - I can convert if necessary);

Age - 28
Salary - £28,500 per annum plus bonus (average year - £3,000)
After Tax Salary - £19,300 (deductions of income tax, national insurance and student loan repayment)
Rent - £160 per month (flat owned by father)
Council tax - £100 per month (local government tax levied from net salary)
Travel Expenses - £250 per month (mainly rail)
Phone & Mobile Device dataplan/HP - £60 per month
Food and Sundries - £200 per month

I have only been seriously saving since November and have thus far accrued £3,500 (I save £500 a month, sometimes more) in a cash ISA (Individual Savings Account) which is tax free and has an annual subscription limit of currently £5,340. Income can be taken from an ISA at any time and is tax free. ISAs can hold most types of assets not just cash.

My staff pension (works like a 401k in rough terms, except the government contributes an additional 20% of tax relief to my contributions in return for taxing my pension income when I finally retire).
I pay 5.3% of gross salary and my employers pay 10%. Fund value is approximately £5,000 now.

Look forward to your comments and if you have any questions about the UK approach to financial planning or investment advice feel free to ask!

Cheers,

Les

[disneysteve]

The typical advice here in the US is to have an emergency fund (EF) equal to 6 months worth of your living expenses. It looks like your expenses total £670. I didn't count the council tax since if you lost your income, you wouldn't have to pay that. That means a 6 month EF would be £4,020 so you are just about there.

Of course, if you lost your job, you wouldn't have the commuting costs which are your single biggest expense, so you could really get by with a lot less, but I think in the £4,000 range is a very safe amount.

Beyond that, start thinking about your other goals in life. Do you want to buy your own home? What about a vehicle? What else do you need to save money for?

[Ochayebeers]

Thanks for the reply Steve,

I haven't decided on the home purchase thing. I know that most people say buying is better but property in the UK is massively overvalued (often you have to borrow ten times your salary even with a large deposit). There seems to be so many factors to consider. What salary multiple do you think is sensible?

Thanks for the second opinion on the EF, think I might let it hit £5,000 as it's a nice round figure. The Council Tax isn't actually levied on income, it's based on my property value (even though I don't own it) and it is fixed. But I think there is some government assistance for that if I lose my job (that can be my homework for now).

My overarching objective is to be financially independent in later life, which I roughly reckon equates to having at least £300,000 in today's terms invested across ISAs, Bonds and Pensions. The State will pay me a pension of £240 per week at current projections (this is what my National Insurance supposedly funds).

I will need a vehicle quite soon but I am dreading the costs. It costs nearly £100 to fill a fuel tank over here (80% of petrol costs are due to tax). So I don't want one until I really need it for work.

Cheers,

Les

[disneysteve]

I haven't decided on the home purchase thing. I know that most people say buying is better but property in the UK is massively overvalued (often you have to borrow ten times your salary even with a large deposit). There seems to be so many factors to consider. What salary multiple do you think is sensible?

Rule of thumb in the US is not to spend more than 2.5 to 3 times income. There's no way you'd get a loan for 10 times your income here.

Thanks for the second opinion on the EF, think I might let it hit £5,000 as it's a nice round figure. The Council Tax isn't actually levied on income, it's based on my property value (even though I don't own it) and it is fixed.

If the tax is fixed and not based on income, then you do need to account for it in your EF. That adds another £600 for a total of £4,620 so £5,000 is perfect.

[Ochayebeers]

Looks like renting is the way forward then! Or maybe emigration to the US! Although President Obama seems to like us about as much as Andrew Jackson did! What kind of cache does a Scottish accent carry in the US nowadays?

Seriously though, buying a house at 3 times salary is something that hasn't happened here for many years - the baby boomers bought most of those. It does make me wonder whether our house prices will crash like in Tuscon AZ for example, but this is a damn crowded island....

[snafu]

My take on Emergency Fund is slightly different likely due to background, experience & taxes. 1st, I think it's important to evaluate the likelihood of losing employment and do your best to make yourself too valuable to be let go. In my view it's important to have 2-3 months of easy to access cash to cover expenses due to loss of employment or even a natural disaster event. I suggest keeping the next 3-5 months of expenses in an income generating vehicle like CD [Certificate of Deposit], Bond, Bond Funds, Index Mutual Fund since any of these can be sold in two business days if your position is stable.

I feel it's important we keep adding to our skill sets, offer articles on LinkedIn, build a professional network and an up-to-date resume which only needs a bit of tweaking if you see an opening you'd like to enter.

In Canada, interest rates are extremely low; mortgage rates currently @ 2.99% for example. Inflation officially @ slightly over 3% but closer to 6% factoring in food, fuel & taxes. Do you plan to invest sums you accumulate in your tax free a/c? Portugal,Ireland,Greece,Spain are being lumped together as European & getting hugely negative press here. I'm interested in hearing a UK perspective.

[Ochayebeers]

Ah,

The PIGS as they are now known. It's actually Italy that is the biggest concern as it has one of the world's biggest bond markets. The latest action by the ECB to begin covert quantitative easing through their Long Term Refinancing Operation seems to have calmed the markets though, and yields on Spanish and Italian debt have dropped accordingly and are out of the redzone. It's just as well because contagion was beginning to spread to France. That would have been a game over scenario. So we can begin breathing again, for now. Greece is bust, the sooner they are ejected from the Euro and can devalue using the Drachma the better frankly. Our Chancellor in the UK has managed to convince the world that our debts (we are the most indebted European nation after Greece)can be repaid due to the austerity program and a few months back our borrowing rates were the lowest in Europe. I think this has more to do with the fact that we have our own currency and can print money instead of having to default. The Euro really has been an unmitigated disaster for all concerned, as Germany is beginning to realise.

Our base interest rate is 0.5% and will stay that way for some time, and our inflation is 3.8% using the CPI measure which is usually an understatement. I know a mortgage is technically cheap right now but I expect high inflation and higher interest rates in the future as you can't print money without consequences. I think if I mortgaged now I would be caught in a 15% interest rate storm like back in the 80's!

I'm quite lucky in that my role is pretty critical and there are no viable replacements in the company, but I have been studying exams anyway as the industry here is becoming very regulated and it always helps to have a few badges. There is a Chartered designation that only 10% of the industry hold and I'm going to go for that.

I'm planning on keeping a cash EF, and regularly drip-feeding into equities over and above that, but I also like your idea of a fixed interest extension to the EF.