You never know when an unplanned financially disaster may strike. Having money set aside for the hard times means you can worry less during the good times.
Whats an Emergency Fund?
An emergency fund is a savings account set aside to cover your expenses in the event of a personal financial dilemma. Your emergency fund offers a safety net and helps reduce the need to accrue interest debt through credit cards or loans.
How Much Should You Have in Your Emergency Fund?
Financial experts have varying views on how much you should squirrel away in case of an emergency. Some financial experts suggest three to six months. Suze Orman recommends eight to 12 months of living expenses to feel truly secure. The long and short, save as much as you can. Even a $1,000 can go a long way in bailing you out during a financial crisis.
What Counts as an Emergency?
Weve all been there, the air conditioner goes out on the hottest day of the year, or the dishwasher suddenly stops working. But do these out-of-pocket costs count as an emergency situation? Should you draw from your emergency fund to cover the expenses?
In the case of the air conditioner, most experts would say yes. You cant live in your home on a 100+ degree day without air conditioning, especially if you have a little one or someone with a chronic condition living in the house. Now when it comes to the dishwasher, experts will advise its better to save for a replacement. You can get by washing dishes by hand if you need to.
These are two minor examples of the types of expenses people weight as an emergency every day. There are many other expenses, like these, that fall into a gray zone.
However, there are some emergency situations that are pretty cut and dry. If you experience job loss, a debilitating illness or a major home repair due to an unforeseen event, such as a fire, by all means, dip into your emergency fund. These situations are why youve saved rigorously to obtain a stash of cash.
Three Questions to Help You Decide if Now Is the Time to Dip Into Your Emergency Fund?
Dave Ramsey recommends asking these three questions when deciding whether to shell out emergency fund money to cover an expense:
- Is it unexpected?
- Is it necessary?
- Is it urgent?
When Is it Best NOT to Dip Into Your Emergency Funds
The questions above provide a great filter for determining when to use your emergency fund. But its often hard to distinguish between a want and a need. Here are some classic examples of expenses that should be covered through saving, instead of your emergency fund.
- Recurring payments and known expenses such as property taxes or insurance bills. You can see these bills on the horizon and know what to expect. Its better to put money aside each month to cover the bills when they arrive.
- Home repairs such as installing new siding or replacing a dryer. While these repairs may be necessary, chances are you may be expecting them. When your siding shows rot and rough spots, or your dryer underperforms more times than not, start saving for a replacement.
- Car repair or replacement is another example of expense that youll typically know about ahead of time. Or, it may be a cosmetic repair to complete after youve saved enough to cover the expense. The exception, if you are in an accident that renders your vehicle undrivable and insurance wont cover the full cost of repairs. In this situation, if the car is your only source of transportation, pulling from your emergency fund may make sense.
If youre like most, it took you time to build up your emergency fund. Use it wisely. When you do have a true emergency and use your funds, work to replace the savings quickly. You never know when youll need it next.