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Note: This is a post from Joan Concilio, Man Vs. Debt community manager. Read more about Joan.
2014 is going to be a “rebuilding year” for my finances. A lot of good things happened in 2013 (and you can read more about the ups and downs of the year here), but some pretty major changes have left me feeling like it’s time to buckle down, get back to basics, work on the fundamentals… insert your favorite sports-team metaphor here! I want to turn things around before a few bad moments become a losing streak.
I think maybe I’m not alone. No matter where you are financially – in debt or not, saving for retirement or not, making ends meet or not – it’s the time of year to get A Plan in place, right?
So as I’m rebuilding my system, I’m going to share a post or two here on Man Vs. Debt each month about getting back to the basics, financially. These posts are adapted from what we shared in our long-running You Vs. Debt course, plus my family’s personal experience. It’s a good time to remind you that I’m not a financial professional – just someone willing to talk dirty about money and hopefully share a couple suggestions!
To kick things off, I thought I’d spend this week and next tackling a topic I’ve fielded in some reader emails recently: The emergency fund.
What is an emergency fund?
An emergency fund is for emergencies, and an emergency is an expense you had no way of anticipating.
Your emergency fund is a separate pool of money used to fund one-time expenses that fall outside of predictability.
We’ll talk about what is – and isn’t – an emergency in a minute, and next week, we’ll talk about how much should be in this separate pool of money and how to get it saved. First, though, let’s hit a couple key points to remember about an emergency fund.
- Location: Your emergency money should NOT be in your main checking/spending account. C’mon. You know what happens. Even when you have the best intentions, something will happen and $20 here and $50 there will get eaten up. I’m OK with linking the accounts, up to a point. For instance, my emergency savings fund is an online account through Capital One 360, and it is paired to our checking account at our local brick-and-mortar community bank, but I purposely do not use my emergency fund as “overdraft protection” on my checking. Nope! If money needs to move between the two accounts, I have to move it.
- Liquidity: Some people prefer to keep their emergency fund in cash, and I think that can work depending on your level of comfort in various systems, your lifestyle and how much money we’re talking about. Whatever you do, you don’t want to make your emergency fund too easy OR too hard to access. In my case, it takes 2-3 days for money to transfer to my checking account from my emergency fund, which is generally fine. There’s a barrier there, as I mentioned before, but not one that prohibits me from accessing my funds. In my mind, an emergency fund does not belong in a long-term investment vehicle that’s hard to liquidate, but neither do I want it in cash around my house that’s easy to fritter away.
So you’ve got a separate pool of some amount of money, gettable if you really need it but not able to be spent accidentally. Now what happens to it?
What should you use your emergency fund for?
I said it above, and I’ll say it again. A (financial) emergency is something you had no way of anticipating.
One of my financial role models, Dave Ramsey, says it well: Christmas is not an emergency! Last I checked, every year, on December 25, there it was. Having your standard prescriptions filled is not an emergency. A sale at your favorite store on that thing you’re going to need anyway? Still not an emergency.
An emergency fund is also not a savings account. If you know you need to save up to buy a new car in the next three years, that money needs to go into a car fund. You know about it. It’s not an emergency. It can be budgeted and planned for.
So an emergency fund is not checking-account overdraft protection. It’s not for buying gifts. It’s not because you get paid next Tuesday and there’s this great sale that ends Monday. It’s not a place to dump your budgeted money for future expenses like vacations or new cars or home renovations. OK, what does that leave?
- Home emergencies: I make sure to budget some money each month into a fund to deal with general home expenses, everything from lightbulbs to paint to minor plumbing needs. But sometimes, something crazy happens. You know, like when my washer randomly freaked out, flooding my finished basement and burning itself out. It was a perfectly good washer with several years of service left, so we weren’t yet budgeting to replace it (or, uh, dry out the downstairs). THAT is an unplanned emergency, and we covered the cost from our emergency fund, which we then replaced over the following two or three months.
- Car emergencies: This is a hard one, because I really believe everyone should have a little bit in savings over time for car stuff. That said, that’s an end goal – not one you’re going to start out being able to do! So, at least as you’re getting started with budgeting, real car emergencies are fair game for your fund. That doesn’t mean routine oil changes – those can be anticipated and budgeted for. But if your alternator goes, sure, I’d say tap the emergency fund.
- Medical emergencies: This is really up and down depending on your situation. If you have access to something like a flexible-spending account or health-savings account, I recommend using that as a medical “emergency fund” of a sort. Again, certain things should not be emergencies. Your routine prescription costs and doctor copays should be accounted for in your overall budget. If you know you have a deductible to meet, that amount should be planned for. But again, a lot of this comes over time (sometimes years and years)! At first, anything that isn’t a standard monthly medical expense might need to come out of your emergency fund.
Notice a theme? Over time, “emergencies” will become fewer and fewer, because you’ll have more money saved up to cover expenses in particular categories.
That said, there’s always going to be a comfort level that you need to achieve with your emergency savings. I can imagine the day when I’m debt-free, including my mortgage, but I’d still feel most comfortable with something like $5,000 in a specific “emergency-only” fund outside of any planned budget categories like health needs or car costs. (And I’ll share more about this idea of what I need to be comfortable in my next budgeting basics post!)
The most important thing is to adjust as needed. If you’re tapping your “emergency” fund every month for $100 for medical expenses, then probably you need to change your overall budget and change those expenses from “emergencies” to “planned spending.”
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As I share these posts on budgeting basics, I’m PARTICULARLY looking for your feedback and questions. (We always love you to comment on our posts, but these are some of the most foundational topics we cover, and we need to know how you’re doing!)
So what questions do you have about an emergency fund?
What would you use it for – and what do you consider NOT an emergency?
Please let us know in the comments!
I love emergency funds. We are on a 8.5 year path to pay off everything. Including our house. So an emergency fund is absolutely critical. The hard part is having to use it and then spend the next several months to build it back up.
We also did something that is like an emergency fund-ish. We know what our deductible is for our house, car, health insurance. So we’ve set aside money in a “deductible” account for when something happens. That way, we don’t feel the sting of paying the deductible of something big happened.
Also, we increased our deductible which lowered our monthly expenses. And then we put those savings into that “deductible” emergency fund. It’s now fully funded and we can enjoy the monthly savings.
http://nakedbudgeting.com/2013/12/30/self-insurance/
That’s awesome! I consider that more of a specific fund (and I have those too – for medical, and a couple other particular categories) but definitely the same idea, it’s there IF you need it, not being saved for a known expense, and you are adding to it as you go!
Hi Joan,
We only have one account set up as an emergency fund which could carry us 9 to 12 months depending on whose income is lost. I do see the need for a car repair fund, but my husband wanted to focus solely on getting our EF to a good place before starting that. We are debt free except our house and are now starting to attack our house for the next three years. We need to discuss if we are going to pay less on the house to create that car fund, in the back of my mind I don’t want to because I’m so anxious to get the house done.
Hey Dani,
I am in the same boat, although I’m finishing off school loans rather than a mortgage. My car is old and I’m not sure how many years I have left, but if it goes (like the engine, I’ve fixed everything else) I will just buy some beater for cash and keep hacking away at my school debt. After the debt is gone, I will trade in the beater and get something for a few thousand more, again in cash. A good strategy from Dave Ramsey.
Dani and Ross, these are good points. In our case, we will not finance anything, ever again, basically, so we are in the boat of, if we DO need a car or repairs, we have to be able to have cash on hand. In our case, the fact that we do only have one car makes it slightly harder, especially as we’re in transition regarding our jobs. There is a possibility that we will need a second car (again, only whatever we can get with cash), and so we’re glad to have that fund!
Some people will say it isn’t “smart” financially to buy a beater for a year or two with cash, but I disagree, because I’m personally not interested in taking on any new debt. Some people disagree, but I feel pretty strongly about it, very much like Ross mentions regarding Dave Ramsey’s ideas!
Hi Joan,
I have an EF of $1000.00 but I have a hard time determining when I should use it. Your post helped but I am still in the bad habit of putting the expense on a CC and then paying that off over the next few months instead of paying back my EF. I think in order to be more comfortable with the method, I need to have closer to $5000 in the fund. I just always think, “oh no, I don’t want to deplete the EF!”
Thanks for the basics post. Even us long time readers need a refresher!
Jamie
Ahhhh! Jamie, I’ve so been there. In my case, I’m 100% not charging anything any more, so that removed a lot of the temptation, but I always felt the same way – oh, I don’t want to use the emergency fund, so I’ll use this credit card instead.
I have to say that I’m not honestly sure how I’d deal with that if we were still open to using credit cards. I think I’d probably have the same temptation, I fear. But in our case, even before that, we started to think of the emergency fund as something to use SO THAT we didn’t have to charge – so if the options are emergency fund or charge card, it would always be EF.
Hi Joan,
Why would you personally want to save for an emergency? If you sent that say $500 fund to a credit card then you have $500 of open credit again. That $500 sitting on the credit card is costing you interest. The money you are saving(emergency fund) is not earning no where near what the credit is costing you. Stop the interest, open that line back up…and there you have your emergency fund. You are saving money doing that.
10 months of no emergency saved you 10 months of interest on that say $500.
A drawback to that is if you pay them and they then reduce your line to what you owe. Instead of leaving the $500 open for you to use they take it away.
Use it or lose it.
Just my 2 cents thought.
Happy New Year to you and all your followers as well.
EM
Your CC company can choose to lower your limit at anytime. I’d save up an emergency fund before paying down credit- Susie Orman even suggests that because CC companies are doing this. She suggests making the min. payment while stashing away some savings- she said it was different then what she used to think.
I should definitely have addressed this in the post, but in our case, we are 100% no-debt, period. So I don’t feel that a credit card is EVER an emergency fund. (Have I been in the place in my life where it was used as one? Absolutely. Nothing in my life has been more humbling than taking out, essentially, a payday loan to get heat in my house when my daughter was an infant.) But that was exactly the reason I said NO MORE to credit cards. That can’t be my backup plan – I don’t want to live that way.
In my case, my credit cards are closed, so I don’t have “open credit” to be concerned about, nor credit limit lowering.
I realize most people already have their opinions about whether or not to use charge cards. I guess the only thing I’d say is that if your goal is to pay off debt, the back-and-forth of paying it down, charging it to cover an “emergency” (and there are ALWAYS emergencies when you have no savings!), paying it down again… that would, personally, drain me. I need to have the balances all going in one direction, down!
Hi Joan,
You must have read my mind! I was literally sitting down with my notebook to do some “figuring” when I saw this post.
I’m still working on accumulating my first $1000.00 in my emergency fund. Not much in my account yet (Also capital one 360) but things are slowly and quietly improving so I anticipate that by May/June, I’ll have that saved.
Can you address the “other” fund we save for? You know (can’t think of the name now) the car repairs, vet bills, gifts, vacation fund etc. I’m working on how to figure out how much I’ll need to save over the year and how to break that down on a monthly basis.
Sending you all wishes for a Happy and abundant New Year!
Linda
Linda, ABSOLUTELY on the irregular funds! I’ve got another post next week about emergency funds, and then later this month or at the beginning of February, I’m going to tackle those. They are a HUGE part of making this work!
Happy new year to you too!
Hey Luke,
I hope your car last for many more months! I too have taken some of my “get out of debt” strategies from Dave Ramsey, with the excetion of the thousand dollar emergency fund. That amount was way too low for my household, and nothing ever cost a thousand dollars, but more like Thousands of dollars. In my opion I think three to five thousand is more of a safety net. I do understand that we are all at different income levels, I would just put off paying down the debt until the EF is built up a little more. Happy New Year!!
Dani, that’s definitely a good point; lots of stuff is more than $1K… in our case, we’re taking a mixed approach and starting from there, but paying down debt hardcore and adding anything extra to the emergency fund to give it a bigger buffer. That said, our end goal is probably to have $5K+ in there at ALL times!
To me an emergency fund is a fund that will cover 6-12 months of rent and food (I don’t have any other crucial monthly expenses). I am not there yet, but working on this goal as we speak. After I finalize my divorce I should be able to step it up even more.
That sounds like a great comfort level, Katybee, and I’m so glad you’re hammering away at it! You can do it!
A great reminder! We are a family of six with a pretty low income and it took us years to save the $1,000 baby emergency fund and then spent time attacking our debt. We will be free of all credit card debt in May 2014!! Then we’ll start attacking our student loans. This month, three weeks before Christmas, my husband’s transmission in his car died and while we had been saving for car repairs, it completely depleted our hard won emergency fund!! That was hard to get through! But, since his Christmas bonus, we have been able to get the emergency fund almost half way rebuilt! And we did not go into debt for the transmission repair. Praise God! We had several years of crawling through turning around our finances and this year, the same month that I gave birth to our twin baby girls, we paid off the equivalent of $8,000 in consumer debt with our tax refund! (I say the equivalent because we settled some of it.) We have had to make huge changes, but they are paying off!
Alex, that is AWESOME. You make a great point that it can be SLOW going, but looking at what you accomplished this year – and without debt on that transmission, which is amazing – makes me smile super-big. You rock. Keep at it, we’re cheering for you!!
We have an emergency fund for 12 months living expenses. Next we are working on 12 months business expenses.
Nothing says those emergency funds can’t be put to good use. We have a much smaller amount that is immediately liquid (ie bank accounts), but the majority of our emergency funds are in higher interest accounts that we can cash out, but could take 1-4 weeks. I’d rather earn 10+% on those reserves than 0.5% at the bank. Even worse, any cash just sitting around is losing 9% value annually due to inflation. Inflation is a hidden tax on stationary money.
Some ideas are money market funds, peer to peer lending, backed private lending for short term, real estate notes (2nd mortgages can be purchased for under 5k), paying down a heloc(careful here, Helocs are not true reserves and can be taken away from the bank at anytime), low volatility stocks, precious metals, high yield cd’s etc etc.
Jason
Jason – I think the David (and Joan) both agree that you can’t, or shouldn’t ‘put those funds to good use.’ An emergency fund, almost by definition, is supposed to be a liquid account. Clearly not the list of investments you suggest. When I read ‘precious metals’ I trust you mean silver or gold? Gold is down 28% this year. A CD might be ok, as the penalty for an early withdrawal is at least quantifiable, often just a number of month’s interest. Maybe you aren’t in the US, where is inflation currently 9%?
Kudos to you that your emergency fund is 12 months expenses, but I suspect that’s not the case. It seems you have a month or so in a true emergency fund, and then a decent investment account, with 6-8 months worth of accumulated income.
Much of the discussion regarding emergency accounts is that they need to be segregated for that purpose. I like Joan’s approach, as it’s the one that makes both psychological and financial sense.
I think you guys might BOTH be right – and it really depends on whether you’re separating the idea of an “emergency” fund vs. a “bucket savings” fund. For instance, an emergency fund helped me when our heat pump went out in our house, and when our washer flooded the basement. A 1 to 4 week liquidation just couldn’t have happened then.
But if I were the investment type, my car-replacement (not repair) fund could most likely go into some kind of interest-bearing fund. So could something like vacation savings (HA, as if I’m at that point yet!) Again, in my case, I’m separating the “emergency fund” – don’t know at all when you might need it, and might need it FAST – from “savings” of any sort for planned expenses, no matter how indefinite, like replacing a car.
Does that make sense? The thing is, I think most people lump them very much together, and their “emergency” fund may be a lot bigger than I say mine is, and a lot less liquid, but it encompasses things that CAN have a less-accessible pool of cash behind them.
Joe,
Fair questions, but your assumptions are incorrect. We have 6 months that are truly liquid. The rest is in less liquid accounts. None of those accounts have penalties for taking my money out, it just takes longer 3-4 weeks. If we have a lost job, our other reserves give us plenty of time to pull money out. Even if you take a penalty, factor it into your calculations. Its a bit of a gamble, but as suggested by Joan, less and less items become true emergencies, so I don’t expect to even tap into our emergency. If we do we have accepted any hits we may take. We will make far more money over the long haul by putting that money to work even if an emergency hits.
True inflation, not the lie reported by the government, is 9% as reported by the American institute for economic research. They report food and energy prices while the US government does not. Please at least take the time to educate yourself on this other data.
You are correct, gold and silver are not investments, but they are good storage houses of wealth for those looking for a hedge against fiat currencies such as the US dollar.
bilgefisher –
Each time the S&P drops from a record high, one can simply wait for the market to bounce back, and collect dividends along the way. The worst period in our lifetime was the decade of 2000 and I survived that just fine. When gold touched $1800 and the gold bugs were screaming ‘buy,’ the ‘storehouse of wealth’ went away. I’m open minded about using gold as a small portion of one’s assets traded each year to maintain a certain allocation, but as a long term hold, it’s useless.
I did look at the inflation site you suggested, their 1 year inflation Nov13/Nov12 is less than the CPI number. Long term, they produce a ten year 3.7% vs the government 2.4%. I actually agree their number is closer to reality. But it’s also nowhere near 9%.
In the end, whatever works for you. Really. 3/4 of people don’t have $2500 available for an emergency, and if they lost their jobs, no funds to make the next mortgage payment. Sounds like you are better off than most, and even if you don’t follow the rules for emergency funds that I think are prudent, you still have a better handle on your finances that the average taxpayer.
Joe,
I understand your arguments on gold. It is why we have less than 2% of our wealth ties into gold. But we do have several months living expenses that could be used from that source.
Sadly your right about 3/4 of the population. I venture to say its likely worse than that. For those people having a cash reserve they don’t touch is extremely prudent prior to dabbling in investments. Building a cash savings should be the first day of financial 101.
Good discussions Joe. I always enjoy a rational debate.
Jason
We have around one year in our emergency fund (it would last longer if we cut expenses as well). We built it up so that I could switch to full-time self-employment and not have to worry about a bad month as much.
Michelle, that’s a great point. And I definitely am finding that as I transitioned into self-employment, my comfort level dollar amount needed to be higher – I think a year for me would feel REALLY great, and while I’m not there yet, I’m certainly trying to move in that direction! Good for you!
This is something I really want to work on for 2014. We ended up in a really bad housing situation and had to dip into our savings big time so we could move. I wish we’d done better about putting money away into savings categories instead of just one big pool of money. Then I would have had a better idea of how much was appropriate to spend on certain things.
Trish, that’s such a good point. And the topic of savings funds vs. emergency funds is a good one too that I intend to tackle in more depth in the future. It is DEFINITELY hard to know what to allocate where!
I’m glad you got out of your bad housing situation, but sorry it hit the savings!
This is something I need to work on in a more systematic way.
I know i need more than $5000 in emergency fund because that covers maybe two months worth of expenses for me and that’s cutting it close and hoping for a miracle if i should lose my job or have a paycut.
That will be our 2014 goal as well!
You can do it, OC!!! 🙂
Great tip about not keeping your emergency fund in the same account, like you say it’s far too tempting to dip into it if you see something you want! At the moment we’re trying to build an emergency fund to cover household appliances and future car purchases. It’s not easy but it’s a great feeling trying to save money, even if it’s only a little. For me an emergency fund is an absolute must have! 🙂
Exactly, Mike. And when I did that in the past, I always swore I was only going to use that money “for a little while” and then bump it back up, and you can guess how that turned out!
i have an emergency fund that can cover my rent/food/expenses for 6 months if I lost my job and went without ANY income at all (no unemployment..but of course I will apply if I did lose my job). I haven’t figured out how to get health insurance for those 6 months tho. So I have set aside an extra amount for that.
PT, health insurance is a huuuuuge thing that we have been factoring in. Costs for our family for private coverage, COBRA, and several other options are truly more expensive than we have EVER used in a year. Yes, there are certainly catastrophic things that could happen, but honestly, if I’m paying $1,900 a month for insurance, I’d rather put that $1,900 into a revenue-producing savings!