Inflation rose to 5.4% in December 2021, pushing electricity prices up by 18.8%, gas by 28.8%, petrol by 27.8% and food 4.5% in a year. And experts are predicting that inflation could reach up to 7% this year!
Those on high incomes may have built financial resilience, but what about those in a less fortunate position? Some have already started dipping into their savings and emergency funds, and inflation is still rising. Here’s how you can protect your emergency fund.
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What can you expect if inflation continues to increase?
Unfortunately, inflation is on the rise, but wages aren’t increasing in line with the rise. Cutting back on luxuries may help, but what happens when essential bills go through the roof? If you lack financial resilience, you might resort to borrowing to make ends meet. After all, you can’t cut back on the things you can’t live without.
This can lead to debt accumulation, further worsening your situation. And to make things even more challenging, lenders have started to change their eligibility criteria to factor in inflation and the impact it has on people’s ability to pay their debts. It won’t be a surprise if you start dipping into your emergency fund if you haven’t already.
How much do you need in your emergency fund?
Sarah Coles, senior personal finance analyst at Hargreaves Lansdown, reminds us that being financially resilient requires emergency savings that cover three to six months’ worth of essential expenses. And if you’re retired, this increases to one to three years’ worth.
Of course, every household has different financial needs based on factors like health, income security and the number of dependents. And besides common essential needs, some people may also have other costs classified as essential because of their circumstances.
Therefore, it may not be possible to give an exact amount each household should have in an emergency fund. However, Sarah Coles does highlight that a “regular person” in the UK might need £5,215 worth of essential costs in an emergency fund. It goes without saying that the bigger your fund, the better.
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How can you protect your emergency fund amid rising inflation?
1. Review your savings every time the inflation rate changes
Coles points out that you need to increase your savings by the new inflation rate when inflation rises. For example, if, on average, you need to save at least £5,215 worth of essential costs for three months, when inflation increases to 5.4%, you need to add (5.4% of £5,215) = £282 to your savings.
Indeed, with the cost of living so high, you may be wondering where to get the extra money to top up your emergency fund. This is where increasing your sources of income and cutting back on expenses comes into play.
2. Increase your sources of income
Consider a side hustle or explore passive income ideas. To get you started, the following articles could help:
- 8 hobbies that you could turn into a side hustle
- 10 profitable side hustles you can start in 2022 and earn up to £20,000 extra!
- Great ideas for passive income in 2022
3. Cut back on expenses
If you’ve cut back on luxuries but still find yourself having a hard time staying afloat, try lowering your spending by reviewing your incomings and outgoings, implementing the three-day rule, introducing no-spend days and switching to cheaper providers.
