Well all know that most personal finance experts will tell you to set aside three to six months worth of living expenses into an easily accessible account in order to cover emergency expenses. But how do you decide what is, and what isn’t an emergency?
The majority of the time, the question is easy to answer. A new iPhone is not an emergency. A weekend trip to Montreal is not an emergency. Fixing the scratches on your car, or getting new seat covers is not an emergency. However, if you get into a car accident, paying for the insurance deductible would probably be a cause where you would use your emergency fund.
But what if your $2,000 Macbook dies, and you need it to keep bringing in an income with your blog? What if your bicycle gets stolen? What if you get invited to a birthday party and you can’t afford a present, or you overspent this month and you know you won’t be able to pay your cell phone bill on the 31st?
Here are four questions to ask yourself before you use your emergency fund:
1. Can you cut out other expenses from your monthly budget?
Before you transfer money out of your savings account, take a hard look at your budget to see if you can move money around to cover the expenses. For example, could you go for a month without your Friday happy hour tradition with your co-workers, or skip out on your hair appointment? A few small sacrifices now might mean you’ll be able to cover the unexpected expense, and you won’t have to replace the money from your emergency fund.
2. Is it really an emergency?
There are often temporary solutions to problems that will allow you to keep functioning until you have saved up enough money to replace an item, or pay for an unexpected bill. For example, you might be able to get an interest-free grace period to pay off the bill, or if your laptop dies, you could borrow one from a friend until you’ve saved up enough money to replace yours – or you could use the computers at the library in the interim.
3. Can you increase your cash flow?
If you receive an unexpected expense, or you think you might not be able to pay a bill before the end of the month, instead of immediately turning to your emergency fund, are there other ways you can increase your income instead? Taking on extra hours at work, selling unwanted possessions, or finding a temporary job might get you through your emergency situation, without having to dip into your savings.
When I lost my job in March 2010, I was devastated. But despite having only $3,000 in my emergency fund, I wasn’t worried. My plan was to take on a part-time job in order to make my emergency fund last longer. I didn’t know how long I was going to be unemployed for, so having a part-time job helped me keep to a regular schedule, while still having the time to search for jobs and go on interviews.
4. Can you decrease the cost of the emergency?
Can you repair the item yourself, or having some do it for you, instead of replacing it? Do you have a skill that you can barter with someone in order to cut down the cost of the repairs? There are plenty of ways to decrease the cost of most emergency situations. For example, if you don’t absolutely need a top-of-the-line Macbook Pro, consider replacing it with a less expensive laptop, or buying one refurbished.
For me personally, I would do whatever it takes to keep my emergency fund in place. It took me nearly 5 years to finally get my emergency fund to $10,000, and the only reason I would touch it is if I lost my job, and couldn’t find a part-time job to keep me afloat. In fact, the only two times I’ve ever had to use my emergency fund is my two stints of unemployment.
My feeling is that as long as I am able bodied and can find more work, sell items I no longer need, or go without whatever it is I need to replace, it’s not a true emergency to me. And I think the key is to decide early on what you are going to use your emergency for – and stick to those rules.
When would you use your emergency fund?
For years, my line of credit was my crutch. I used every available dollar of credit available to help me limp from month to month, or whenever an “emergency” arose.
Times have certainly changed for me. I just hit the $10,000 mark for my emergency fund – which represents 4 months of comfortable living based on my current needs – or 5 months of living on a bare-bones budget. However, now that I’ve been debt free for a few years, I’m often asked why I don’t use a line of credit as my emergency fund instead – leaving me with the entire $10,000 – which I could invest in something that might earn me more than the 1.50% interest that I’m getting right now.
Some personal finance bloggers believe that a line of credit is the perfect solution to a true emergency. But I’m not one of them. I’m a full believer in having a cushion made of cash, not credit. :)
Here are 5 reasons why I will never use a line of credit for an emergency fund again:
- Savings means having breathing room: Having a cushion allows you the freedom to work through your emergency without having to go into debt at the same time. While it’s true that the money in your emergency fund will eventually run out, the same can be said about a line of credit. The difference is, after your emergency money is gone, you will still be debt-free. And should you need to look into other options for a long-term emergency situation, you will be that much farther ahead.
- Credit lines aren’t savings: The most obvious problem with using a line of credit as an emergency fund is that you eventually have to pay it back. If you are forced to use your emergency fund, then you are clearly in an ‘emergency’ type of situation. Why would you want to face the added stress of piling on debt? If you’ve ever had to use your credit card before to make an unexpected purchase, then you’ve probably experienced the stress involved with trying to figure out how you’re going to pay it off. The same can be said with a line of credit. Don’t think the lower interest rate will be easier to handle than that of a credit card! Debt is debt, and it is stressful no matter how much it ends up costing you.
- The bank controls your credit line: A huge obstacle with using a line of credit is that you are at the mercy of the bank, as well as fluctuating interest rates, and changes to policies and procedures. If your line of credit is secured by your home equity, you have the added pressure of knowing that you will be putting your house is at risk.
- Credit doesn’t offer security: An emergency fund is meant to act as a cushion. If you stumble, it is there to catch you, no strings attached. You don’t have to worry about payment schedules, interest rates, or mounting debt. Relying solely on credit means that you are always living on the edge. Having cash in the bank gives you options. You call all of the shots. Not only will your own money give you a solid sense of financial security, but there is something to be said about the confidence it will give you as well. Knowing that you can handle virtually any situation that comes your way is an empowering feeling.
- Nobody is immune to emergencies: Remember that no matter how stable your job might seem, or how good your health is, nobody is immune to emergencies. And sometimes, you just don’t know how long you will be stuck in that kind of stressful situation.
Being faced with an emergency is the absolute worst time to go into debt. Protecting yourself from life’s inevitable obstacles is a huge part of creating financial security. Having an emergency fund will open up doors for you during a period in your life where you will need all the help you can get.
Would you use a line of credit as an emergency fund?
For long-time readers, you know that I’ve suffered major setbacks in trying to get to this $5,000 mark, such as being unemployed for nearly 3 months (and having E.I. take 11 weeks to get me my first payout!), ending a 1-year contract, crashing and totaling a car (whoops), and let’s not forget last year when I found that my job was posted on Craigslist behind my back.
This number is meant to represent one of the following scenarios, based on having zero income:
- 3.5 months of comfortable living, based on my current budget
- 5 months of bare-bones living, based on my current budget
- 2 months of comfortable living, based on paying rent/mortgage and my current budget
- 3 months of bare-bones living, based on paying rent/mortgage
Those numbers aside, the best part about how my income is structured, is that my FT job only represents 70% of my overall income. My PT job and freelance/blog income brings in the other 30%. So that means, if I should lose my PT job and freelance/blog income, I will still be able to get by with the income from my FT job quite comfortably. This means, I wouldn’t need to touch my Emergency Fund, and I’d still be able to save money too.
Now, if I lost my FT job for some reason, I’d still have 30% of my income coming in. And I can imagine that if I had all of my time to dedicate to my PT job and freelancing/blogging, I could increase my income through those channels. By how much, I’m not sure. But considering I bring in over $2,000 a month in PT/freelance/blog income right now, if I lost my FT job, I don’t think I’d need to take much money out of my Emergency Fund each month – if at all.
Crunching these numbers makes me feel at least a little secure with the amount I have in my Emergency Fund account. This is just a base amount for me, because I know that in the big picture, $5,000 isn’t going to be enough to get me through a long-term emergency. It is, however, a humongous step towards my goal of becoming financially independent.
Going forward, my long-term goal is to have $10,000 set aside in my Emergency Fund. I have come to this amount based on the above numbers, the cost of a mortgage, future children, and other variable factors – like my employability factor, drive to make money, multiple streams of income, etc. For larger household emergencies – like costly repairs – I also have a general Savings Fund that I can dip into, should my EF not be enough to cover the cost.
My plan of attack is to now set aside $50/bi-weekly towards my new goal of $10,000.
How much would you need in your Emergency Fund in order to feel comfortable?