Rainy day funds - how to manage an emergency cash pot
- by Ellen Ward
- Thu, May 02, 2024
- 5 minute read
Having a rainy-day fund is a lesser discussed but still important aspect of managing a wider investment portfolio.
It can seem counterintuitive to think cash might have a role within a wealth growth strategy that needs stronger growth opportunities over the long term in order to meet your financial goals.
However, cash does have a role to play and central to that is a rainy-day fund.
What is a rainy-day fund?
A rainy-day fund is a pot of cash you can draw upon in times when you need quick access to cash.
What this ‘need’ is depends on your personal situation. At one end it could be for a small emergency such as your car breaking down and needing a costly repair.
At a more severe end of the spectrum a rainy-day fund can give you protection and breathing space were you to lose your job through redundancy or have a loss of income for any other reason.
A rainy-day fund is also relevant in the context of retirement income. If you’re reliant on the income from your investments to fund your lifestyle, then this can sometimes come with market fluctuations that affect your portfolio.
In this regard, a rainy-day fund is important because it can help you access cash reserves when investment markets are down and prevent you needing to sell assets and crystallising losses unnecessarily.
How to structure a rainy-day fund
The first question to ask yourself with the fund is how much you think you might need. Once you’ve met this target, make sure to revisit the amount you have in the pot to ensure it keeps up with your changing costs.
Remember, putting too much of your assets into cash can have a negative impact on your wealth growth, so there should be a limit to what you might need to get by in an emergency, or in the short term.
In terms of where you keep your rainy-day fund, easy access savings accounts will be your first port of call. While interest rates on such accounts are better than they used to be, they are likely to come down in the near future, heightening the need for a limit on how much exposure to cash your portfolio has.
For the purposes of a rainy-day fund, easy-access savings accounts are better than a current account because typically they will pay better rates, while still being readily accessible.
Such accounts are also protected by the Financial Services Compensation Scheme (FSCS) up to £85,000 per eligible person, per bank, building society or credit union. If you intend on having more than this set aside in cash, then it is essential to divide it up into different accounts.
When it comes to whether you should keep this cash within a tax-free ISA wrapper – it is important to consider that within the wider context of your portfolio.
The ISA allowance should chiefly be set aside for long-term investments rather than short-term cash funds. Your long-term earning and growth potential will be much better served by the tax-free protection an ISA offers.
Savings come with a tax-free £5,000 incentive on earnings from interest, but you’ll only be eligible on this if your other earned income is below £17,570. This includes your personal allowance of £12,570 so for every £1 you earn above the personal allowance you’ll lose £1 of savings interest allowance.
If you’d like to consider how best to structure this it is important to discuss with a financial adviser first in order to ensure your wealth, be it cash or investments, is organised in the most efficient way possible and to ensure you can hold cash for a rainy day without it having a detrimental impact on the long-term prospects for your portfolio.
