One of the first things people save for is an emergency fund. It’s hard to predict what might happen to us. An emergency fund gives us a sense of security in knowing that if anything should happen and income stops flowing in, there will be some financial safety to ensure we don’t end up on the street. The general rule of thumb for an emergency fund is to save enough for 3 months of expenses. This means in case of any unfortunate event, there will be enough money to keep the lights on, put food on the table and keep a roof over our heads. As the name of it states, an emergency fund is used for abnormal events. Many people often misconstrue the meaning of an emergency fund and use it for the wrong purposes.
What An Emergency Fund Is Not Used For
If anything the emergency fund usually gets abused for things that are not considered emergencies. Even thought unfortunate events happen that require monetary attention, it doesn’t mean that it should be taken from the emergency fund. Some things should be saved for because they are known expenses ahead of time.
1. Home Renovations and Maintenance
Home renovations and maintenance are not an emergency. Yes, it’s possible to live without granite counter tops and hardwood floors. Renovations and standard maintenance are standard costs that should be accounted for when owning a home. Paying a mortgage does not constitute the entire cost of owning a home. People that aren’t familiar with home maintenance costs should go read up on it in one of my previous posts.
We all get stressed, but dipping into the emergency fund just to get away to Mexico to relieve stress does not constitute as an emergency. Vacations are rewards that we give ourselves for a job well done. Obviously we can’t have everything in life so it’s necessary to set aside savings so that we can enjoy life away from work and stress of our homes. If vacations are important, it should be something that is budgeted for on a yearly basis. The fact that a friend decides to call up and go to Florida next weekend shouldn’t be a reason to pilfer the emergency fund.
3. Shopping Sprees
Those shoes at the mall were must haves! Unfortunately, if the bank account doesn’t agree with the price it’s a sacrifice that must be made. The need to get an outfit for the weekend does not count as an emergency. It might be a fashion emergency, but it’s not a financial crisis that warrants dipping into money that was saved for dire needs. Yes, it’s possible to live without those purple shoes!
4. House Down Payment
Hot housing markets are everywhere but America. This doesn’t mean that dipping into the emergency fund just to outbid the other horny house hunters is justified. Don’t get over emotional when buying a house to the point that winning the house is an emergency. The emergency fund might be used to pay down the monthly mortgage or rent because times are tough, but that’s different because it might mean living on the street otherwise. Not buying a house is not the end of the world.
What’s The Source?
1. Cash Savings
Good ole’ cash. Nothing beats the safety of putting an emergency in a bank account that cannot be easily accessible. This means that the account should be not drawn upon through debit transactions at the cash register. Nor should it be used to pay regular bills and write cheques. If cash is used, the emergency fund should be sitting in a bank account that is separate from day to day banking and it should be made as difficult to get access to it as possible. The reason for difficult access is so that we don’t get tempted to draw upon it when it’s not really needed.
2. Line of Credit
To be honest this is the preferred approach if the individual manages their money well. Someone with a well diversified, balanced portfolio can easily liquidate their portfolio within days to cover any shortfall that might occur from using the line of credit for emergency purposes. The advantage of using a line of credit is that the amount saved for the emergency fund can be put to work for you. There is no point having cash lying around that does nothing for you. A line of credit can act as a short term buffer. To top it off, having a line of credit that is never used may actually help your credit score!
Starting the emergency fund is the hardest thing to accomplish. Proper budgeting is important. Start off by using the 10% saved on income for the emergency fund. Once that is established then start looking at ways to invest savings. Regardless if an individual has debt or not, start saving for the emergency fund. I know it’s never wise to think negatively, but it’s important to have something there to have that peace of mind.