Prepare Yourself for Unexpected Expenses: How to Plan for the Future

The Importance of Building an Emergency Fund
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Introduction

One of the most important aspects of personal finance is being ready for unexpected events. No matter your salary level or investments, the first thing you are looking for is peace of mind. If something happens to me, will I be ok? Am I able to deal with my car breaking down, the flight home from my holiday being cancelled or my boiler breaking?

This isn't just about having spare cash, which is important. It's also about managing the savings you do have to ensure that they are liquid. What do we mean by liquid? Well, a liquid asset is one that can readily be converted to cash or cash equivalents. You can have all the money held in investments in the world but if you're unable to convert it into cash in your back account in time to cover the expense, it's useless.

For that reason, we usually encourage people to first build up 3 months of living expenses in a readily available cash account, and then, when they've made sure they have no long term outstanding debts, to move this up to 6 months. Having 6 months of living expenses readily available will mean that you should be amply covered for all but the most disastrous of financial catastrophes that may befall you.

Debunking Myths About Unexpected Expenses

The famous saying goes, "The best time to plant a tree was 20 years ago. The second best is today" and this holds true for savings. You don't know you need an emergency fund until something happens, by which point it's too late.

What’s Not True and How to Plan Ahead

So what actually is an unexpected expense? We ask this because many expenses that people think are unexpected, are actually just overlooked. If you have an annual car insurance premium that needs to be paid, and it pops up without you having budgeted for it, that's not unexpected. That's overlooked.

Unexpected Expenses Myths

It can also be tempting in times of financial stability to invest this in stocks or bonds, but the reality is that there will be times when the value of these investments could fall dramatically, and it's often precisely these times that you need the money!

For example - an economic downturn is the most likely time for you to lose your job, and also the most likely time for your investments to fall in value. Financial outcomes are heavily correlated, so you'll find that when it rains, it pours.

The Truth About Unexpected Expenses: Planning for Financial Surprises

Stocks often also have a settlement time. You won't be able to sell them when markets are closed, and many brokers take at least a few days to sell the stock, credit your account and then pay out the proceeds.

For this reason, it's best to avoid stocks entirely for your emergency fund. Cash is safest - ideally in a non-committal savings account that pays an elevated level of interest to normal accounts, but is available to be transferred to your main account instantly.

As we mentioned, 6 months is ideal although this may vary depending on your circumstances. If you own your property outright and most of your spending is discretionary, you may need less. If you're renting your property and housing a family who are wholly reliant on your income, you are at higher risk and will need more.

Common Misconceptions About Unexpected Expenses and Future Planning

How to Plan for Unexpected Expenses: Dispelling the Myths

There are a number of steps you can take to plan for unexpected expenses.

1. Have monthly family budget meetings. Hold these with an accountability partner - that's your spouse if you're married, or a close friend, family member or housemate if you're not. Having someone to hold you accountable can mean that you don't only have someone to call you out when you go off course, but they'll be with you along the way too!
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   It's also super helpful to have an extra pair of eyes to "sense-check" your budget. Often you can overlook or miscategorise things, and some things are subjective so it's important to have someone check what you've done.
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2. List your possible overlooked expenses. By very nature, these are easy to miss so you'll have to be methodical. Have you covered off Groceries, Cars, Kids, Health, Seasonal, Memberships & Subscriptions, and Gifts? Each of these categories have some basic expenses and some extras. Your car expenses aren't just insurance but also routine maintenance, repairs, tyres, oil changes and more.
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   Add a "random" column. This might include things like replacing computers, vet visits for your pet and more. If in doubt, we say just add an extra 10% onto your existing expenses.
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3. Build overlooked expenses into your budget. You can now categorise these and add them to your existing budget. If any are big enough to be slightly overwhelming, you might want to set up what's called a Sinking Fund. This is a way of saving up for larger things by splitting it into smaller monthly bites. For example, putting £100 away each month for the 6 months leading up to your expense, so that you gradually build up to having enough to cover it.
   
   Again, make sure this is in an easily accessible account.
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4. Finally, the meaty part! An emergency fund. Research shows that only half of Britons have more than £1,000 in savings. This is incredibly concerning! Of course, we're not here to make judgements on people's financial situations but if you at all have the means, we'd strongly urge you to first build up £1,000, then 3 months, and finally 6 months of living expenses in a readily accessible account as mentioned above. This will make sure you're covered for all but the most extreme financial disasters.
   
   It's also very unlikely that you'd need to access more than 6 months of living expenses immediately (same day), so money you save beyond that can be invested into things like stocks and bonds that take a little longer to access, so that if you do need them for some reason, you can plan a little further ahead to access them.

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Preparing for Unexpected Expenses: What do do when an Unexpected Event Hits

First of all, stay calm! You've planned for this if you've followed some or all of the steps above. Your monthly meetings mean you have a great idea of where you're at financially, most of your unexpected expenses are covered and you have a small safety net if you need it.

When something does happen, you have 3 options, depending on the severity of the event. Firstly, if possible, you can cover this using the miscellaneous line item on your monthly budget. Secondly, if this doesn't quite cut it, you can cut spending elsewhere that month to make sure you have enough to cover the new expense. Finally, if it's serious, you can dip into the emergency fund in order to save the day.

Before you touch this money, you should ask yourself if it actually is unexpected, urgent and necessary before dipping in. If it doesn't tick all 3 of these boxes, you should consider starting a sinking fund to cover it, or using your monthly discretionary spending.

The Reality of Unexpected Expenses: Effective Future Planning Strategies

It's okay if you don't implement all of this immediately - what's important is that you're well aware of the sort of things you might have to spend money on, and ready to make plans to cover them. It's never too late to start being more conscientious about your personal finances, so get cracking!

Conclusion

Finally, don't forget that in order to get a complete picture of your personal finances, it can be very useful to monitor all your accounts together. We've built a number of features on the Strabo dashboard that allow you to plan for future events, particularly large life events, and break down what accounts this cash might be available from, or where you might have to re-allocate. You can sign up today at the top of the page and let us know what you think!