Your Emergency Fund Archives - Faithful with a Few

Set Clear Definitions For An Emergency

The only way to have a successfully functioning emergency fund is if you set very specific definitions as to what constitutes an emergency, and you never dip into the account unless the crisis fits neatly within the definition.

Everyone’s concept of an emergency fund tends to be a little bit different, but I think that the key definitions are sudden and unexpected. Sudden, as in an event that seems to come out of nowhere. If it is something that you knew was coming, it does not fit within the definition of sudden, and is not a legitimate emergency.

“Unexpected” is another critical definition. If a financial event is truly unexpected, it means that you had no reason to prepare for it in advance. Anything that you do know beforehand should hardly constitute an emergency.

A job loss, for example, can qualify as an emergency because it is sudden and unexpected. Replacing all four tires on your car doesn’t fit either definition, because it is a maintenance item that you knew about long in advance.

An Emergency Fund Should Never Be A General Use Bank Account

An emergency fund should be an account that is special and set apart from the rest of your finances. If you are using your emergency fund simply to cover monthly budget shortfalls, that is not a true emergency fund. It is important to maintain that distinction, otherwise an emergency fund is simply not an emergency fund.

Your checking and savings accounts should represent your general use bank accounts. That means they are available to cover your normal budget, as well as any expected expenses. If there is an imbalance here – that is, an insufficient amount of money in these accounts to cover your expenses – then you have a structural financial problem. The problem could either be insufficient income, or excessive spending. An emergency fund will not fix either of those problems, nor should it be expected to.

Set Up A Budget Account To Handle Expected Expenses

One of the ways to avoid imbalances in your budget, is set up some sort of budget account. This should be an intermediate level account. It should be more accessible than your emergency fund, but less so than your checking and savings.

While your checking and savings should be available to meet your normal spending budget, and your emergency fund is held for true emergencies, a budget account can function as a halfway type of account.

You won’t use this to pay regular bills, but rather you’ll use it as a an account to pay for anticipated expenses. This will largely include maintenance costs and near-term spending priorities. Knowing these expenses are coming up, a budget account will enable you to put money aside in anticipation of meeting them.

Maintenance costs that you should be funding through your budget account can include:

Expected car repair expenses. If for example you expect to average $1,000 per year for car repairs bills, you should be putting away about $80-$90 per month to budget for this.

A roof replacement that’s expected in five years – if the cost will be $6,000, you might want to begin saving about $100 per month in anticipation. The 60 months between now and then will allow you to save the money you need.

Your refrigerator is ten years old, and it will cost $1,000 to replace; figuring it will last another two years, you may want to begin saving at least $40 per month ($1,000 divided by 24 months).

Near term spending priorities might include some of the following:

Saving up money for a family vacation. If you know that you’ll be spending around $3,000 for your vacation, you should be putting $250 into the account each month ($250 X 12 months = $3,000).

Holiday expenses. You can think of your budget account as being something like a Christmas club account – putting away a certain amount of money in anticipation of heavier expenses at the holidays.

Your eight year old looks like she may need braces in a few years – you can begin saving for this in your budget account.

Each of these expense types are fully expected, and therefore they are hardly emergencies. You can and should budget for them, and by having a budget account set up you can do just that. If you do it faithfully, you will not need to raid your emergency fund, nor drain your regular checking and savings accounts.

It seems a bit complicated, but can you see the merit of having dedicated accounts to cover different levels of expenses?

When we think of financial independence we often think about having a lot of money, of having a fully loaded retirement plan, a house that’s paid for and being able to spend money any way we want.

That may be financial independence on the high end, but you’ll never get there without taking a few less glamorous steps beforehand. One of those steps is creating an emergency savings fund. It will be the foundation of everything that comes afterwards.

Why An Emergency Savings Fund

You May Not Be Ready For Stocks, Bonds And ETFs – Yet

Talk about financial independence often focuses on investments. Where’s the market going? What are the hottest stocks? What winning ETF will get me to my investment goals? How much do I need to save for retirement?

That’s all good, but if you don’t have any of those activities going right now, you need to back up and do something more basic. You need an emergency savings fund. As boring as it sounds, an emergency fund does several things that will start you on the road to financial independence:

It gets you a basic savings balance
It proves that you can save money, which is critically important if you never have before
It provides a measure of insulation between you and financial desperation
It lays the foundation for greater savings—and investments—later
When you have investments, an emergency fund will keep you from having to liquidate those investments to pay current expenses or emergency situations

I think it’s safe to say that until you get the items above going, financial independence will never be much more than a dream.

Starting Off On The Wrong Foot

Financial resources have three main components in most households: income, savings and credit. Each of these can be used to pay obligations, but they aren’t all equally up to the task.

1. Income. This is the preferred resource to pay obligations, especially current ones. When your income meets your current obligations your household budget is under control and you’re ready to move on to better things.

2. Savings. In a perfect world, savings should be available to back up your income in the event that it isn’t enough to cover your immediate expenses. You’re in a good place if that doesn’t happen too frequently, but it’s there if you need it.

3. Credit. Credit should be used only for the purchase of major assets that will provide you with benefits for a long period of time. It’s a way to spread the expense of high cost items over a longer time frame. Houses, cars and a college education are the best examples, and even then only if they aren’t taken too far. Credit can also serve a secondary role as the back-up to your savings, in the event they won’t cover a large run of expenses.

Income and savings are the preferred financial resources, with credit as a need-to-use-only resource. The problem is that for many people, it’s not savings that backs up their income, but credit. This comes about because while savings take time, effort and sacrifice, credit comes about with the swipe of a card.

The need to save money is skipped entirely. That’s bad because having savings, and at least an emergency fund, has fantastic advantages…

An Emergency Savings Fund = ”Sleeping Money”

Have you ever lost some sleep, or even an entire night’s worth, worrying about paying your bills? More specifically, this is likely to happen when you really can’t pay your bills. This is what happens when your budget is stretched too tight, when there aren’t enough resources to meet obligations.

If nothing else, having just a few thousand dollars sitting in a savings account might bring you the blessed sleep that you need to live your life.

Debt Can’t Go Away Until You Stop Using It

An abundance of debt is usually accompanied by an absence of savings. Is there a connection? I think so.

When you have no savings, you’re forced to rely on credit to cover those income shortfalls. And when you’re constantly tapping your credit lines, you’re going deeper into debt.

Most people who are in debt would do just about anything to get out, but that can’t happen until you stop using credit. The only way to do that is to live on less than you make and be prepared to cover emergencies with your savings—a true emergency fund.

Being Ready For Trouble

When you have savings—at least an emergency fund—you’re ready for problems. It’s not that you want them to happen, but rather that you’re prepared if they do. Any trouble you face will be that much easier to deal with if you have a savings cushion to back you up. Savings give you options, and that can take the panic right out of a troubling event.

The more you have saved the more trouble you’re ready to deal with. But at a minimum, you should have an amount sufficient to cover predictable shortfalls, such as major car repairs, medical deductibles, or a job loss.

When you’re ready for these, life becomes more predictable, and that puts you in better control – it’s almost like having a self-funded insurance policy.

How To Get There

There are different ideas as to how much you should have in emergency fund, but I think the best is having at least an amount equal to 30 days of living expenses. If you have 30 days of expenses saved, you’ll have enough to cover the first month of a job loss, which will give your unemployment checks a chance to start showing up.

How do you reach that goal?

Start by selling anything you don’t need with a garage sale or on Craigslist, and banking the money.
Bank your bonus, your tax return or any gift money you receive.
Bank 10% of your net income for the next ten months, or use some other percentage strategy that will get you there. A temporary part-time job can help with this too.

Any difficulty you’ll encounter in building your emergency fund will be less than the trouble you’ll be getting out of by not having one. That’s the first step to financial independence. Everything else will flow from that.

Have a Budget Account – To Keep You From Raiding Your Emergency Fund