Emergency Fund Definition: The Do’s and Don’ts
It’s happened too many times. You save up some money in your emergency fund and start to feel good about your finances.
Then, a financial emergency comes along and wipes it all away. You’re back to square one.
It’s no wonder you’re frustrated!
But how can you jump off this perpetual roller coaster without getting hurt?
First, you need to accurately define emergency fund and the types of expenses it’s to be used for.
Emergency Fund Definition
In personal finance, an emergency fund is simply defined as an account where you set aside funds to be used for unexpected expenses.
It’s your “just in case” account.
In The 9 Steps to Financial Freedom, you’ll notice the emergency fund is mentioned in two separate steps.
It’s first mentioned in Step 4 where you save up a little cash before starting to eliminate your debt. You want to have something saved up so you don’t need to rely on debt when a financial emergency inevitably arises.
I recommend you save up one months worth of your essential expenses (basic housing, utilities, food, etc.) in Step 4.
The emergency fund is mentioned again in Step 7. This is where you save up a larger emergency fund after you’ve eliminated your debt.
In Step 7, you really want to pad up your savings so if a more long-term financial emergency arises (e.g. job loss), you can weather the storm much longer.
I recommend saving up at least 3 months worth of your essential expenses in Step 7 with many of you needing 6+ months depending on your circumstances.
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Emergency Fund Examples
Here’s where the issues begin.
You see, everyone has a different opinion as to what constitutes a true financial emergency.
Well, let me (your financial coach) help you define it properly.
Your emergency fund should only be used under the following circumstances:
1. Unexpected Job Loss
If you lose your job unexpectedly, you may need to start pulling from your emergency fund.
2. Unexpected Medical/Dental Expenses
If you or someone in your family (pets included) suddenly becomes ill and your health insurance doesn’t cover all of the cost, you may need to use your emergency fund to pay some of those bills.
Just don’t forget that even after insurance, you can negotiate these costs and pay less than the full price.
Use a site like Healthcare Bluebook to determine what a fair price for the procedure is.
3. Unexpected Travel
If you have a family member suddenly become ill or pass away, you may have some unexpected travel.
Your emergency fund is there for these types of expenses.
4. Unexpected Car Expenses
If your primary vehicle needs immediate repair so you can continue to get to work and earn an income, your emergency fund should be used.
However, the thought of car repairs may send you into a panic.
You start to worry about additional costs in the future.
While this may be true, there’s no way for you to know.
There’s no need to run out and finance a new car.
I don’t know about you, but I’d rather spend a little money here and there to fix my car vs. taking on a car payment.
5. Unexpected Home Repairs
If it’s zero degrees outside and your heating unit gives out, you’re going to need to use your emergency fund.
There’s no way around it.
However, if your refrigerator door starts squeaking, just spray some WD-40 on it and move on.
There’s no need to go out and buy a new one.
Rebuilding Your Emergency Fund
When a financial emergency occurs and you need to dip into your emergency fund, you need to start replenishing it immediately.
If you’ve moved on to a different step in The 9 Steps to Financial Freedom, you need to pause that step and return back to the step where you fund an emergency fund.
Therefore, if you’re on Step 6, you’d reduce your debt payments back to the minimums and use all of your leftover income to rebuild your emergency fund.
The same can be said for the larger emergency fund.
If you’ve moved on to Step 8 and are saving aggressively for retirement, you want to scale that back and rebuild your emergency fund.
This will accelerate the rebuild and you’ll get back to funding your retirement or paying extra on your debts that much sooner.
Just remember, The 9 Steps to Financial Freedom are all about focusing on one key aspect of your finances at a time.
What About The Other Financial Emergencies?
So what about all of those other expenses that depleted your savings in the past?
They were probably things like gifts, vacations, insurance premiums, school field trips, sports uniforms, etc., right?
Those types of expenses are not emergencies.
They’re not even unexpected. They just occur at irregular intervals.
If you sit down and think through these types of expenses, you can plan more appropriately for them.
For example, if you know that you’re going to spend $1,200 during the holidays, you need to start saving several months in advance.
Even some of the expenses you think are unexpected (e.g. school field trips), are actually not.
You know they’re going to occur, but maybe just not when.
Just set some money aside for these types of expenses on a monthly basis and dip into it when needed.
Plan Ahead For Irregular Expenses
One of the best ways to plan ahead for irregular expenses is to create an annual budget.
By viewing the next 12 months of income and expenses, you can see if an irregular expense will fit into the month it normally occurs.
If it doesn’t, you’ll need to start setting aside money for the expense several months in advance.
For example, if your car insurance is $600 and it’s due every six months, you might want to save $200 per month for the three months before the premium is due.
If you can’t budget $200 per month, you need to start saving $100 per month for the six months before the premium is due.
By planning ahead, you’ll have the money set aside and you can pay the bill without having to dip into your emergency fund or worse, having to take on debt.
Real-World Emergency Fund Examples
To help illustrate the importance of an emergency fund, I thought I’d share a few examples of people that used theirs for unexpected expenses.
A Stinky Situation
Lauren Greutman recently had a sewer drain back up in their basement. After being displaced from their home and facing a large bill to fix the issue, their emergency fund was there to save the day. It helped alleviate the stress of the situation so they could focus on getting the problem solved.
From Job Loss to Dream Job
After Matt Becker lost his job at a software company, his emergency fund allowed him to focus on starting the business he dreamed about, a financial planning firm for new parents. If that cushion wasn’t there, things would be way different today.
A Baby Is Born
Shane Ede and his wife checked into the hospital anticipating an easy delivery of their baby girl. However, things ended up becoming scary when their baby was born with Meconium. She needed to stay in the hospital for a week and the last thing the Ede’s wanted to think about was money. Luckily, they had an emergency fund and were able to come out of it unscathed.
Kali Hawlk recently needed to take her ailing kitty to the emergency vet. $2,000 later, the kitty was better and Kali was able to weather the financial storm thanks to her emergency fund.
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Those stories illustrate the true uses of an emergency fund and now that you know the true definition, it’s time to commit to never using it for other purposes again.
Here’s what I want you to do:
- Grab a blank piece of paper and think about all of the irregular expenses you have throughout the year. You may need to look at your statements to help jog your memory.
- Write these expenses down and include the dates you need to pay them and how much they normally cost.
- Create an annual budget and start plugging in these irregular expenses.
- Adjust the expenses in your annual budget until you’re able to not go over budget in any given month.
- Start saving for these expenses in separate savings accounts.
- Pull the money when the bill is due and start saving for the next time!
Now get out there and jump off the financial roller coaster. Figuratively that is!
Now get out there and take care of your money, so it can take care of you later.
Your financial coach,