Financial planning gives you control over your wealth. By creating a budget, you can track your income and outgoings so you’re able to afford a good quality of life now while also saving for future goals.
However, there are times when you can’t control everything because life can be unpredictable. Sometimes, you might face unexpected costs such as damage to your home, a broken down car, or a family member in need, which don’t fit into your budget.
If you haven’t considered how you’ll pay for these surprise costs, they could disrupt your financial plan.
According to IFA Magazine, 60% of UK adults are worried about the effect that an unexpected expense would have on their savings. Additionally, 23% of people are concerned they wouldn’t be able to cover extra costs if they arise.
That’s why it’s important to think about how you will raise the extra cash to pay for an unplanned expense if you need to.
Here are four options to consider and some of the potential challenges to keep in mind.
1. Use your emergency fund
Your emergency fund is there to act as a buffer in unpredictable situations, so you can comfortably cover additional expenses.
If you have a healthy cash savings account, you should be able to afford to replace the boiler or get your car fixed without having to rely on borrowing.
Ultimately, this means you can absorb unexpected costs without disrupting your financial plan in the future.
It’s important to remember that, once you’ve spent a portion of your emergency fund, you might need to increase your contributions for a few months to build it up again. That way, if you have a run of bad luck and face many additional costs, you should be able to deal with them.
You may also want to review the amount you hold in your emergency savings regularly, to check that it’s reflective of the current cost of living, which may rise over time.
For example, Statista reports that the average price of a new boiler increased by almost 44% between 2015 and 2023.
If you don’t expand the size of your emergency fund as prices rise, you might find that a single unexpected expense uses up a much larger portion of your savings than you thought it would.
2. Cash out your investments
In some cases, you might not have enough in your emergency fund to pay a large expense, so you’ll need to consider alternatives.
For example, you could cash out investments to raise additional funds. This might benefit you if you want to avoid borrowing, but it’s important to consider what kind of investments you sell and the potential downsides.
Selling Premium Bonds, for instance, may be a useful way to raise cash and there is no Capital Gains Tax (CGT) to pay. The value of Premium Bonds isn’t dependent on market movements either, so you don’t need to worry about selling at a loss.
Conversely, selling stocks and shares may not be a sensible idea for several reasons. Firstly, if you hold the investments outside an ISA, you may have to pay CGT, depending on the profits you earn.
Also, if you sell during a period of market volatility, you could make a loss on the investments.
Even if you do make a profit on the investments, cashing out of the market could mean that you miss out on valuable returns in the future. So, selling investments to pay for emergency costs might benefit you in the short term but could affect your ability to grow your wealth and reach long-term goals.
3. Borrow on credit cards
If your emergency fund is not adequate and you don’t want to cash out investments, you could use a credit card to pay an unexpected bill.
Provided you have good credit, you should be able to get quick access to a reasonable amount of cash on a credit card.
Despite this, it’s important to consider how borrowing on a credit card will affect your budget moving forward.
The interest rates can be relatively high, meaning you face expensive monthly costs in the future. This could make it more difficult to manage your budget moving forward and might affect your ability to contribute to savings and investments.
For smaller expenses, a credit card may be suitable as long as you can pay off the balance quickly. Yet, you might want to explore alternative options for larger costs so you don’t find yourself restricted by high monthly repayments for a long period of time.
4. Take out a personal loan
Personal loans might be a more suitable option for significant expenses. For instance, if you need to do extensive work on your home, you might be able to take out a loan from a bank.
You may find that the interest rates on a personal loan are much lower than a credit card, and you can pay it off over a longer period without worrying about the spiralling cost of borrowing.
If you factor the repayments into your budget, you can pay emergency costs in a sustainable way. In some cases, you might be able to overpay the loan too, meaning you clear the debt faster.
Bear in mind that some lenders limit the amount you can overpay by, so make sure to check the small print before agreeing to anything.
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Please get in touch or email us at advice@mlifa.co.uk for more information.
Please note
This article is for general information only and does not constitute advice. The information is aimed at retail clients only.
All information is correct at the time of writing and is subject to change in the future.
Please do not act based on anything you might read in this article. All contents are based on our understanding of HMRC legislation, which is subject to change.
The value of your investments (and any income from them) can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.
Investments should be considered over the longer term and should fit in with your overall attitude to risk and financial circumstances.