When and Why to Use Your Emergency Fund
"Save for a rainy day" is some of the most vague advice I've ever heard. I had to google the origin of it, because I feel like I've never fully understood why it's used so often to refer to saving money. Apparently it means "we know it's going to rain sometime, so we should prepare," and "put something aside for a time of need."
Sounds great. Be prepared. That was the Boy Scouts motto, too. Unfortunately, these "timeless" lessons of life have fallen on deaf ears if nearly 70% of Americans have less than $1,000 in the bank. If you are in the minority with some savings, or maybe even a comfortable emergency fund (three to six months worth of expenses), have you ever wondered what to do on one of those "rainy days"? Maybe it's time we talk about our relationship status with our emergency fund. Like... what in the world are we doing all this saving for, and if and when should we ever use those hard-saved dollars we've set aside. And what about sunny days? Or snow days?
What is an emergency fund?
An emergency fund is savings set aside... wait for it... an emergency. Sounds simple, but if you don't define what constitutes an emergency, it will be too easy to shift your definition as life goes on. Going to Costco for a few essential items and coming home with a kayak does not warrant a dip into your emergency fund.
If you want the kayak, save for it. Then buy it. The kayak is not bad, it's the manner in which you acquire the kayak. This doesn't have anything to do with your emergency fund. The emergency fund is there for certain situations that are unexpected.
How to calculate your expenses for a X-month emergency fund
If you are trying to determine how much should be your goal for your emergency fund, the easiest/most conservative way would be to look at your household income on a monthly basis and multiply that number by how many months you would like to have in your emergency fund (three to six is suggested).
If you have great self-awareness and can calculate how you might cut your expenses in the case of an unexpected loss of income (which would constitute an emergency), you might be able to squeeze that monthly number down a little bit.
- What would you cut from your budget in the event of a job loss?
- Do you tithe on your income? If your income goes down, you would tithe less.
Think through the expenses that would go away, subtract them from your monthly income number and then multiply that by the number of months you are savings for.
Criteria for using your emergency fund
It's one thing to build a habit of living below your means to help reach your goals, but the emergency fund by nature is something you hope to never have to use. If life went perfectly, you'd never have the temptation to dip into the savings to help in time of need. But, that's not realistic. So, what criteria would trigger a valid withdrawal from the emergency fund?
- Does the situation affect your income? Did you lose a job or have a temporary, unexpected drop in income?
- Does the situation affect your ability to earn income? This would include a short-term disability, illness, accident or any other event in which you have to take time off work unpaid. Even if you have long-term disability insurance, that usually kicks in after 60 or 90 days. How will you cover expenses until then?
Emergency fund mindset
As you work hard to build up enough savings to cover three to six months worth of expenses, there will be temptations to dip into that fund for other things. It's hard. When I had very irregular income a few years ago, we ended up using our emergency fund to help cover the short-fall of income. We probably could have done better in that situation at looking at other alternatives first (like cutting our lifestyle expenses), but knowing we had the emergency fund was what we ended up using.
We were vulnerable. Because my income was down, we were stressed, and Kelsey was pregnant at the time, so we made some poor choices with how we used our emergency fund. We didn't see any other way. And at the time, we hadn't really ever talked about how or when we would use our emergency fund.
Until that situation, we never thought about using our emergency fund. It was always there at our fingertips, but our mindset was such that we never wanted to use it. Now, we're working hard to replenish it (we're about 1/3 of the way there) and pay off medical bills from last year. When we had a fully-funded emergency fund, we didn't have to save extra money into that budget category every month. We could use those dollars for other goals.
Building an emergency fund is an as-needed thing. Once it's full, you can move on to other goals, but once you dip into it, then you need to work to get it back to where it was. An emergency fund protects your income and provides security against the unknown.
Steps to take before using your emergency fund
- Cash Flow: Try to shift and wiggle the rest of your budget before dipping into your emergency fund. Do you have other savings categories that you could do without for now? Vacation fund, clothing, fun money, home maintenance...can you shift some dollars from a handful of categories to cover the cost? This would keep your emergency fund in tact.
- If it's broke, does it HAVE to be fixed?: Home repairs can creep in and disguise themselves as emergencies. For us, we've stretched out finishing our basement. It's taken us three and a half years and we're about 90% finished. It's a functional space at this point, but nothing has to be done. It's all wants. We won't be using our emergency fund to help get us to 100%. But, along the way, we've had a garage door, water heater and washer go out, car repairs and a few other minor emergencies that have come our way. We've managed through them. Some we've dipped into our emergency fund for, others we managed through cash flow like #1 suggests.
- Replenish: If you do have to dip into the emergency fund, how quickly will you be able to replenish? A job situation would be a very big deal (mine was self-induced and planned for, and we still blew through our "job transition fund" quickly), but a sudden loss of a job would require an extensive use of your emergency fund. Finding another job would be your main job while your emergency fund keeps things afloat at home. But, if it's a large car repair bill or something of that nature, replenishing the emergency fund after things are settled will be top priority before going back to other goals.
Every situation is different and everyone will treat their savings differently. If you've never thought about it before, hopefully this will give you some parameters to ponder as you work toward your long-term financial goals. Building and keeping a three to six month emergency fund creates great peace of mind and frees your mind to work on your other financial goals. It's not always fun to save up for the money to just sit there, but when the rain comes, you'll be glad you did.