How should I distribute my savings?

Question

TL;DR How much should I keep as an emergency fund and how should I prioritise/distribute anything surplus to this?

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I currently have about 5-6x my monthly salary in savings. Currently I keep this all in an instant access ISA, but as my savings grow, I realise there are better ways I can use the extra money.

My options seem to be:

• pay off existing loans
• store money in a different account without instant access for higher interest rates
• invest (I'm quite ignorant about investing however)
• pension (I don't currently have a plan).
• change nothing

Some other information:

• I have a car loan with about £12000 outstanding
• I have a mortgage with about £80000 outstanding (this is shared between 2 of us)
• I have a student loan. I don't know the outstanding amount and payments are taken straight out of my pay. With the current government plan, this is written off after approximately 30 years (that's 25 years remaining)
• I'd like to have children in around 5 years.
• I'm in the UK.
• I'm 25

Answer 1

You need to track all of your expenses first, inventarize all of your assets and liabilities, and set financial goals. For example, you need to know your average monthly expenses and exactly what percentages interest each loan charges, and you need to know what to save for (your children, retirement, large purchases, etc).

Then you create an emergency fund: keep between 4 to 6 months worth of your monthly expenses in a savings account that you can readily access. Base the size of your emergency fund on your expenses rather than your salary. This also means its size changes over time, for example, it must increase once you have children.

You then pay off your loans, starting with the loan charging the highest interest. You do this because e.g. paying off $X of a 7% loan is equivalent to investing $X and getting a guaranteed 7% return. The stock market does generally does not provide guarantees. Starting with the highest interest first is mathematically the most rewarding strategy in the long run.

It is not a priori clear whether you should pay off all loans as fast as possible, particularly those with low interest rates, and the mortgage. You need to read up on the subject in order to make an informed decision, this would be too personal advice for us to give.

After you've created that emergency fund, and paid of all high interest loans, you can consider investing in vessels that achieve your set financial goals. For example, since you are thinking of having children within five years, you might wish to save for college education. That implies immediately that you should pick an investment vessels that is available after 20 year or so and does not carry too much risk (e.g. perhaps bonds or deposits).

These are a few basic advices, and I would recommend to look further on the internet and perhaps read a book on the topic of "personal finance".