A critical part of getting healthy financially is having an emergency fund. If you are alive you can count on the fact that Murphy will show up from time to time. Sometimes he shows up in small ways like when the alternator goes out on the car or the water heater in the house springs a leak. Sometimes he shows up in more serious ways like a lost job or a major medical issue.
Once you have your emergency fund though how do you decide when to use it? What constitutes an emergency?
Decide before the emergency hits
I drove by the car lot and saw a really cool looking new sports car, so I need to replace my car! This is not an emergency.
I can see the road beneath me through the rust spots in my floor board so I think I need to get a new car. This might well constitute an emergency. Cars with holes in the bottom haven’t really been a good idea since the days of the Flintstones.
When you are feeling the car fever though you may not make a wise decision. This is why it is wise to set some guidelines for yourself regarding when you will use your emergency fund.
What is the consequence of doing nothing?
In a real sense this is really a question of needs vs. wants. You want to be careful that you are using the emergency fund only for needs that are truly emergencies. Even repairs that need to be done may or may not be emergencies. Ask yourself does it have to be fixed today? What will happen if it isn’t taken care of today? What will the consequences be? If the “emergency” is really just an inconvenience that will not lead to a bigger more expensive emergency, then consider saving up to pay cash for the item and keeping your emergency fund intact.
For example suppose your home has really old windows. They are ugly. They are very poorly insulated and let lots of cold air in in the winter. And they are starting to deteriorate rather badly. Do they need to be replaced? Yes. But could you live with it for another few months, save up and pay cash for replacement windows. Probably so.
Now lets say those same windows have deteriorated to the point where there are large holes starting to appear. They leak badly when it rains and you are starting to see evidence that the leaking water may be starting to cause problems in the surrounding walls. This would be an emergency that needs to be fixed right away because if you don’t you may be faced with replacing an entire wall or worse.
You can judge each situation appropriately, by considering the risk of not addressing the problem immediately.
The benefit of inconvenience
One way to keep from dipping into your emergency fund for things that aren’t really emergencies is to keep it somewhere that is a little inconvenient. Keeping cash in the sock drawer probably isn’t a good idea. It’ll be too tempting when it’s Friday night, you’re tired, and have no desire to fix dinner. By the same token keeping it in the same bank account that you use for your day-to-day finances is not a good idea either.
I prefer to keep my emergency fund in a separate account. I actually keep mine with a completely separate banking institution, but that isn’t really necessary. The point is you want it clearly separated so that it requires a conscious decision and some action on your part to dip into it. This will help force you to be deliberate about using funds from your emergency account.
The more healthy your finances the fewer “emergencies” you will have
The other thing that I believe you will find is that as time passes and you continue to live a debt free life, you should find your savings continue to build up and you’ll have fewer and fewer things that require you to touch your emergency fund.
Additionally, over time you should be saving for things like car repairs and replacement and home repairs. So when the car needs replaced, it’s not really an emergency. You know cars don’t last forever. You simply take the money you have been saving and use it to replace the car.
Having an emergency fund with at least 3-6 months of expenses will change the way you live your life. There is a peace that comes from knowing that you have enough saved to live on for a few months regardless of what happens to you. Once you experience that peace I think you will find yourself more and more reluctant to dip into that emergency fund.
What would it feel like to know if you lost your job or had a major medical issue, that your family could survive several months on your savings?
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