Emergency Fund

Emergency Fund

Emergency Fund (Photo credit: 401K 2012)

I’ve talked a bit about having a good emergency fund, so it’s probably about time I define what an emergency fund is, and maybe more importantly, WHAT IT IS NOT. There are many people who have already defined this, but I want to get a little more detailed and answer the questions; Why, How Much, Where, and For What.

Why?

Why should you have a pile of cash that is used exclusively for emergencies? It’s a fair question, because after all, if money is just sitting there, it’s not out working hard for you. And though I believe all money should have a name so you can use it for something productive, this does not mean that you need this money to be active. An emergency fund functions as a brick wall to block out potential financial disasters.

When an emergency arises, you’d better have the cash to take care of it, otherwise that emergency will haunt you for far longer. If you don’t have the cash on hand, you will throw the cost of that emergency on a credit card and NOT pay it off before the end of the billing cycle. You will then pay interest on your emergency, which is just rubbing salt in the wound of having to deal with the emergency in the first place. If you have an emergency fund, your  BIG EMERGENCY will become nothing more than a minor inconvenience. You can focus on the emergency at hand instead of wondering how to finance this mess!

Also, having a pile of cash earmarked for those unexpected events that inevitably arise helps you sleep better at night. I know I do! I don’t worry about things that might happen to our house, or one of our cars getting stolen (partly because I buy cheap cars, not new ones), or the long list of things that might cause us financial turmoil. I’ve already go it covered.

How Much?

So now that we’ve established having money set aside for emergencies is a good idea, how do we figure out how much to save? Dave Ramsey talks about this in his book, The Total Money Makeover (highly recommended, btw. You can read why in my about page).  He recommends saving a small emergency fund of $1000 while you are still digging your way out of consumer debt. Then, once you are debt-free (except the house), put away 3 to 6 months of expenses worth of savings for your full emergency fund. My recommendation is very similar: Save $1000 to $2000 while you are still in debt, and save 3 to 6 months worth of income when you are debt free.

My reasoning is that it would really take the wind out of your sails in your debt payoff plan if you had an emergency that cost over $1000 and brought you back into credit card debt because you didn’t have enough saved up. I agree with Dave on the 3 to 6 months of expenses. I recommend 3 months for those with multiple incomes from stable jobs. For those in one-income households, I recommend closer to 6 months.

I recommend coming up with a pared down budget of just your necessities when projecting your expenses. This is because in the event of job loss, you will not keep investing, saving for gifts and vacations (savings buckets), or have any extra money to spare. You will be on a strict budget that is probably much less than your normal monthly budget until your income is back. So if you normally spend $3000 a month on your expenses, savings buckets, debt payoff, etc…Your emergency budget will likely bring you closer to $2500 or $2000 a month. You will halt debt payoff, investing and savings buckets, and just pay for the necessities. I hope that makes sense.

Where?

So now that you are saving up an emergency fund for the reasons stated above, where are you going to store this cash? I suggest not keeping it in your checking or savings account where you have immediate access to it. If you do this, you run the risk of tapping your emergency fund for non-emergencies. Now, I know my readers have more self control than that, but I certainly don’t! Here’s my method for stashing away your emergency fund:

  1. Keep $1000 liquid in your savings account for small emergencies that you need to pay cash for. This allows you immediate access to cold, hard cash if the need ever arises. To be honest, I have yet to run into a situation where cash was required, but it might happen.
  2. Put the rest of your money in an online money market account. I suggest using someone reputable, such as ING Direct or Ally Bank. I personally have our 3 to 6 month emergency fund stashed away in an ING account. The money takes about 3 days to transfer to our checking account, putting a natural barrier between me and my millio…err…thousands of dollars saved for emergencies. This helps keep me from buying a sweet pair of kicks or a motorcycle with my emergency fund.

For What?

Now the real question. When do I get to use this sweet, sweet cash money?! You don’t. Seriously. Stop staring at this pile of cash and drooling over the possibilities. You should probably forget this money even exists. You emergency fund is meant for true emergencies only. A hole in your sock is not an emergency that requires a new wardrobe. A scratch in your car doesn’t mean you can now declare a federal state of emergency and go buy a new car. And yes, even minor car repairs are not an emergency (because you having a car repair fund in your savings buckets for that….right?).

An emergency is a completely unforeseen circumstance that puts you without a necessity. You are required to fix this issue or you will be without something that you actually need. An example of this is that our hot water heater died. This put us without hot water, which is something my wife and I have decided is a necessity. We used our emergency fund to buy a replacement so that we could have hot water again that evening. If you are injured and need medical care that will cost you out of pocket after insurance, that is an emergency. If your cars dies (like, truly dies and is irreparable) and you have no other commute option, that is an emergency.

And when you happen upon an emergency, you should have no guilt or qualms about paying for it with your emergency fund. That is what is there for. This is where the peace of mind really comes into play, and your emergency that could be life altering and put you behind for months becomes nothing more than an annoying pest that you squash with your emergency fund.

Side note: You probably shouldn’t do what my wife and I do, which is start rooting for our appliances to fail. Every time I hear that the refrigerator is leaking something, or the washer or dryer is acting up, I get excited and start looking at replacement appliances like I’m a giddy kid Christmas shopping at the mall. In reality, we should have a savings bucket for appliance replacement! Haha!

Comments: Do you have an emergency fund? Have you ever used your emergency fund for a non-emergency fund? What was your excuse? How much do you have saved up in case of emergencies? And seriously, why can’t woodchucks chuck wood? I have a pile of fence in my backyard that could use chucking right about now…

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Comments

  1. kristine Paulino says:

    I read your blog all the time, I really enjoy it. Makes me think…

  2. Personally in my situation I’m not a big believer in having a hefty emergency. I do make a point of keeping at least $1000 easily available, but that’s about as far as I go. I’d just rather have my cash working for me somewhere better than an online bank account. If something did arise I could put it on my credit card interest free for 1 billing cycle and then transfer it to my line of credit. I just think an emergency fund is more suited to people who have had debt problems.

    • I agree with the part that the size of your EF should be based on your situation, but I do not think it’s wise to put an emergency on a credit card, only to transfer it to a line of credit. Unless you really enjoy paying interest on emergencies, then go for it.

      I am still toying with the idea of finding somewhere more lucrative to put part of my EF, but it kind of defeats the purpose of having a reliable chunk of money that’s always there. Emergency funds are kind of like comprehensive insurance against life events. Except you are paying yourself, not some other company :)

      • Yeah I’d rather pay a bit of interest on the rare emergency instead of losing interest each and every month. I’m just not a fan of Ramsey or his principals. They are intended for people with debt problems and just doesn’t make sense for a lot of people.

        • At least you have a plan in place, that’s a good thing! Honestly, I have definitely considered putting a bit of my EF into some investment that I know really well, just so my 6 months of expenses is doing a little work for me. The important thing for me is to know that it is my cash and available to me when I need it.

          I have a special place in my heart for Dave Ramsey. Some will say he’s too elementary, but his advice is just what I needed at the right time! He has definitely focused on those struggling with their finances because that’s a majority of Americans. Like he’s said, if people were good at math, they wouldn’t be in the type’s of horrible financial situiations they find themselves in.

          I am curious what about his principals you find to be disadventageous? You can PM me if you don’t want to post a response here :). Just wondering, because I’m always open to learning new things and better ways of planning my finances.

          • No I’m sure his strategies are advantageous for people with debt problems. I just find that for me personally, his advice just doesn’t make sense. I don’t agree with things like paying off the smallest debt first and funding an emergency fund while in debt. I admit I don’t know all of the strategies he recommends, nor have I read any of his books. If it helps people that’s awesome. For other people though that can just result in paying extra interest or missing out on extra investment interest.

          • Gotcha. Good to know. I would submit that Dave Ramsey is more a motivational speaker than anything. So that’s why some if his strategies might not be the best for people that can figure out how to efficiently pay off debt and save on interest. You’re spot on there.

  3. I have around $15K in an EF. Both his job and my job are extremely stable though so we do want to scale back on this. However, our EF covers basically everything, job loss, something going wrong with the cars, house, etc.

    • That’s an awesome fund you’ve got there. Two stable jobs means you should be able to scale back to 3 months of expenses without any worry. Isn’t it nice to know that pile of cash is there and you can have it pummel any emergency that comes along?

  4. Pasadena says:

    I’d like to add my voice to that. I started saving as much as I could one year ago. I don’t have much, but it just saved my cat’s life. He’s in the hospital right now, still fighting for his life. If I didn’t have money, he would be dead now. And I can’t tell you how much it helped knowing that I could pay when I brought him to the ER the other night. I had to empty my savings account and am just now starting to borrow from the EF.

    So when I think about it, all those things I didn’t let myself buy, all those things just saved my cat’s life. I realized, in the course of a few hours, that I just swapped material, instant gratification stuff, for my cat’s life. And this has no price.

    If you have kids, or older parents, just think about that. It’s not only being able to pay for a new water heater.

    • Wow, so sorry to hear about your cat, but definitely glad to hear that you started building a fund that in turn saved his life!! And you’re absolutely right. Health issues are the most important emergency that you can have, and you’d better have some real cash on hand to take care of those. I think our society helps influence us to think that we’ll live for a long time and health issues won’t affect us until we’re older. But when that cancer diagnosis comes in, or someone in your family gets seriously injured, the last thing that should be on your mind is “how am I going to pay for this?” Money is pretty low on the totem pole of priorities at that point, and should not influence your decisions to take care of those emergencies. Having and emergency fund takes money out of the equation and allow you to focus on what’s important.

      Thank you for that reminder.

  5. An emergency fund is critical or it’s just a matter of time before you’re in hock to a high-interest lender and holding on for dear life. I think of an emergency fund as a sentry keeping the credit card companies from worming their way into my life and making me their slave.

  6. I’m still currently building up my real emergency fund. My reasoning behind this is that I currently am also building up a car fund and a medical fund. In a real emergency, both of those could be grabbed. I like having the idea of a car fund because my little $500 car can kind of suck sometimes. We want to be able to purchase a new to us car and also be able to pull from that fund for any maitenance for our current car or for tags. This way I’m not pulling from our emergency fund for non emergency reasons. Same for the medical fund. We eventually want to be able to put at least 3 months worth of expenses into it. But we are also trying to get out of debt so it’s being slowly built at the same that that those other funds are.

    • Sounds like a solid plan to me. Once you are out of debt, you can really bulk up the EF. I call the other savings you have put away “savings buckets”. You save up for a car replacement, or car maintenance, or medical expenses, etc….because those are expenses you can predict and save for, they are not emergencies. :)

  7. I have an emergency fund but it has gotten depleted the last few months. One of my current priorities is to get it replenished.

  8. Having that $1,000 – $2,000 in the bank while you’re paying down debt is so, SO important! My EF has been wiped out lately, so I have to build it back up, but I still have a couple of other savings buckets I could touch if another emergency came along before I can build it back.

    • It really can kill your momentum if you don’t have this money in place while plowing through your debt. What a bummer to spend a few months knocking out a few thousand dollars in debt, only to have it reset because your cat flushed the toilet too many times in a row and floods the basement!

  9. So this is the third post this week that I’ve read and enjoyed that touted of Dave Ramsey’s wisdom. It’s like someone’s trying to tell me something…or it’s possible that I just read a ton of PF blogs these days. I better read his book and find out! I agree with the EF advice entirely. We have about $1000 in our EF currently as we are climbing out of debt, but I don’t feel “secure” with that amount and won’t until we have several months’ pay set aside. That way, if God forbid, anything happened, we would be able to sustain while picking ourselves up or looking for alternative sources for income.

    • You should read it! It’s a great motivator! Getting out of debt is a tough process and having a cushion can help keep you going. If you don’t have a plan in place for emergencies, you’ll always be worried that something can come along and ruin everything you’ve worked for.

  10. Keeping liquid money with you all the time as well as keeping some assets is a good way of going.

  11. Great post explaining the basics of the EF. LOL at “hole in your sock” not being an emergency.

    We have about 6 months of bare bones living expenses in our EF. We have never used it for anything (mind you we are not homeowners or parents yet). Once we own a home and I am a SAHM we might increase it a little bit. It’s good that my husband has discipline b/c without his accountability I would probably be dreaming of shopping sprees…

    We also keep a bit of a cushion in our checking account for various unexpected expenses that are not emergencies but also not within our normal budget. Recently, when a family member was ill in the hospital, we were able to spend more on gas and eating out and coffees than we normally do without having to worry about overdrafting our account.

    • Emergency funds are SOOO tempting to raid! Seriously, I could get a sweet ride right now…..BUT NOT WORTH IT!

      I like te idea of a buffer in the monthly budget. Since we are a month ahead, we have our expenses planned to the penny, but I always know that something can and will come up to throw us off. Having a buffer helps cashflow those smaller “emergencies” and not have to touch any savings.

  12. guys & gals, old guy here. just heard of dave ramsey in the past few years. we went thru decades, getting thru school, raising babies, etc and NEVER had an EF until we stumbled across him. Since that time, we built up a bit of an EF and wow did that help us out. Kid needed a new car (beater), grand daughter had serious medical problems, as did our daughter, FIL died – lots of expenses involved with that, and on and on and on. Great thing about it was that we were able to cash flow all of those crises because we actually had an EF in place. Please – just do it – way sooner than we ever did. You’ll never regret it.

Trackbacks

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