A central tenant of personal financial management is the establishment of an emergency fund. On its surface, the concept of the emergency fund is pretty straightforward. It should be a highly liquid savings fund covering at least six months of essential expenses. Its purpose is to protect you from unexpected, sudden events that would require significant cash quickly. But this basic definition leaves plenty of room for interpretation. In reality, the times when it’s appropriate to dip into an emergency fund depend on the person, the urgency of the situation, and what really constitutes an emergency. Since these factors vary for everyone, keep some simple guidelines in mind to be prepared and act quickly when faced with a serious situation.
“An emergency fund is an insurance policy for yourself.”
The rule of thumb requiring six months of expenses for an emergency fund follows the assumption that it will be used in the event of sudden unemployment. A pink slip is a completely acceptable excuse for tapping into these savings. Other events that always qualify are medical emergencies not fully covered by insurance and the sudden death of a close family member. In his personal finance blog, Dave Ramsey offered three points of consideration when evaluating a withdrawal from the fund: 1: “Is it unexpected?” 2: “Is it absolutely necessary?” 3: “Is it urgent?” Generally, every event that meets all three of those criteria is one for which you should not feel bad cashing out your savings. Think of the emergency fund like an insurance policy for yourself.
The Question Marks
Even with those three rules in mind, a real emergency is still hard to define. Leah Manderson wrote about her experiences with emergency savings, and posted a description of the three times she had to dip into the fund. One scenario involved her car, which showed signs of aging for a while. When the car had its 100,000 mile inspection, there was an urgent problem with the front axle that rendered the car unusable and would cost $1,500 to fix.
This problem wasn’t entirely unexpected – the car was getting old and she had been repairing things for a while. But because she depended on the car to get to her job every day, it was both an urgent and absolute necessity to repair it. Even though it wasn’t a catastrophic misfortune, the emergency fund should cover something like this. Keep in mind that not all financial emergencies are life-threatening.
Now that you know when you definitely should use your emergency savings, when should you definitely not use them? Manderson also discusses a situation where she probably shouldn’t have used her savings: to pay off debt. After accumulating some questionable expenses on credit card bills, Manderson was $2,500 in debt. She used savings that should have been used in an emergency to pay it off all at once, assuming that would be better than allowing it to accumulate any longer. This is not always a smart move because if a life-threatening situation came about soon after, the emergency fund would be depleted. If you accumulate debt from credit cards, adjust your budget to pay it off incrementally and keep your savings for a real emergency.
When in doubt about using your emergency fund, if you can live without fixing the problem immediately, it probably isn’t an emergency. Remember the three rules of unexpected, necessary, and urgent and you should be fine when making that important decision.
The views expressed by the articles and sites linked in this post do not necessarily reflect the opinions and policies of Cash Central or Community Choice Financial®.