Home > Money Management > Budget Basics #9 – Saving for an Emergency Fund

Budget Basics #9 – Saving for an Emergency Fund

What is an emergency fund?

Businessdictionary.com defines an emergency fund as this: Money which is set aside for an emergency situation, such as unexpected unemployment or injury, or a natural disaster which destroys one’s home and belongings.

Get Rich Slowly has a great blog with several links to articles by notable authors’ regarding an emergency fund.  Rather than try to duplicate all of that content, just click here and check out the resources yourself.

I personally like Dave Ramsey’s approach to an emergency fund.    He recommends you target $1,000 as your emergency fund, which should cover a lot of unexpected expenses and repairs.  While it may be good to have an emergency fund that would cover 3-6 months of you expenses, it will take years for most people to save that amount of money. It’s hard to get started and motivated towards and impossible goal, but everyone has the ability to save $1,000 over time.

As most of the material written about emergency funds states, there is no universal formula to follow.  Each person and situation is different.   Keep in mind that few people can save enough to cover every potential emergency and crisis.  Just like insurance, there are too many catastrophes to protect against.  All you can do is cover the most likely risks and have faith that everything else will be okay.

One of the most important things about an emergency fund is tapping it only for genuine emergencies.  What’s an emergency?  Once again… that’s going to be your call.  When drawing down your emergency fund, a key thing to remember is the amount of time it will take you to replenish it.  If it takes you 6 months to save the same amount of money again, how will you cover another emergency during that period?

The following is an illustration of determining an emergency.  Every vehicle needs regular maintenance which includes brakes and tires.  Depending upon vehicle, 4 tires can easily cost $400-800.  Tires generally last about 25,000-35,000 miles.  If you drive 12,000 miles per year, you know that you’ll need tires in 2-3 years.  Is it an emergency when you have to replace them after 3 years of driving?  Is that different than having a blowout 6 months after you purchased new tires?

Why do so many people reference 3-6 months of expenses?  Assuming that you have disability insurance, you’ll find that many policies have a 13 week waiting period (i.e., 3 months).  The other principle is that 3-6 months gives you time to make adjustments.  During this time you hope to be able to find another job, relocate, trade cars, sell certain assets, etc.  It won’t be easy or pleasant, but in many areas of financial planning, time can be your best friend.

So… if you don’t have an emergency fund, start one this week.  Even a few dollars a week will eventually compound into an amount that can make a difference.  If you currently have an emergency fund, take a few minutes to evaluate your current situation and determine if it’s sufficient for your present level of spending, debt and peace of mind.

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  1. May 21, 2012 at 8:54 PM

    Depending on your emergency fund (EF) needs, split beweetn the EF and the car loan. But the crux of the matter is not really how to divert your leftover savings, but how to increase those savings to erase your debt burden more quickly.Saving depends on1) Increasing Income (often less feasible).2) Decreasing Expenses (often more feasible).Most people focus on #1, and neglect #2. But most expenses can be decreased dramatically, or even eliminated. Share rent with lots of people, or live at home or in a low-cost area if possible, avoid owning cars in the near future (they suck a lot of money), eat out less, buy less (or better yet, nothing) or secondhand, don’t engage in expensive sports/hobbies, no travel/tech gadgets/brand names/movies, etc. Reduce all water, power, phone, mobile + cable bills to the minimum. Analyze your biggest expenses (usually rent/car/food/leisure/bills), and find ways to cut all the financial fat. Since you’ll have a lot of extra time on your hands, use it to invest in educating yourself and developing your professional talents/interests/skills so that you can achieve a higher future income potential. Go DIY don’t pay others to teach you.Live poor because actually, you ARE poor. By my personal definition, if you need a job in order to feed yourself, you’re poor. If you need to worry about what your boss thinks of you, you’re poor. If you’re in debt, you’re in the hole poor. Don’t be generous or ashamed you literally can’t afford to be. Be generous and proud after you’ve saved up some $ $ $ . Extreme situations call for extreme measures. If you compare yourself to other people with lots of debt, you’ll feel your situation isn’t so bad, but you should be comparing yourself to people with positive net worth. I only make 18K/year now, but I save about 10,12K more than 50% savings on income. I’ve been doing this for many years now, so it all adds up. So despite my low income, I had my basic 1K EF in my first month. I intentionally chose to live in a lower-cost city that didn’t require a car, and in the beginning I had to forego a lot of costly urban enjoyments (movies, dining, shopping, etc.). But the payoffs have been tremendous; I don’t worry about money or jobs. Plus, I only work part-time now. If you can find a way to save 1K a month, you’ll be well on your way. It’ll only take 20 months to pay off all your debts. If you have higher income and can save 1.5K, you only need 13 months to be completely debt-free.After you pay off your debts, you should continue your hardcore saving for a couple years, (1yr =12K, 2y=24K, 3y = 36K, depends on what your long-term financial goals are), after which you can invest your savings, and your money can start working for you, instead of you always working for money. Then you can ease off on or abandon the Spartan lifestyle. If you’re a guy, you might not want to though, because being a Spartan is actually pretty cool. It’s good mental physical training, because it helps to cut away all the consumer materialist crap in life. Makes you focus on what’s really important in life which is ironically, not the money, but yourself, your relationships, and your purpose in life. And coincidentally, all those 3 things suffer when you’re working the 9-to-5 grind and spending nearly all of your hard-earned money on whatever. Best wishes to you –

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