Every financial guru on the planet says the same thing: Build an Emergency Fund.
And we all know we need to. It just makes common sense.
But is your emergency fund functioning like it should?
Or do you dip into it over and over throughout the year? Do you feel like you spend all your Goal-striving energy on just replenishing the pot?
If you answered 'Yes' to the second question, then it sounds like your emergency fund is functioning more like a part of your operating fund.
Going from one emergency to the next
When you manage your money in that way, you are constantly cycling from one emergency to the next, never really making progress on other goals because you’re constantly reacting to life and Murphy’s Law. When you’re not adequately prepared, Murphy moves into your spare bedroom. (Not literally, figuratively, of course)
Remember Murphy’s Law? “Anything that can happen, will happen”?
A true emergency fund is for events that we could not have predicted and that have to be fixed immediately. We don’t have time to save up for them.
For example, a child breaking an arm, or a furnace going out in January.
Which ours actually did.
An unfortunate example
We had let our home warranty expire a few months previously because we couldn’t stomach paying over $700 for another year of coverage.
Using our emergency fund for the $600+ repair (parts & lots of labor to figure out the problem) was manageable. And it was worth paying for the extra labor to avoid paying $4000 for a new furnace.
But the HVAC guy gave us some bad news. Our furnace would likely need to be replaced in less than five years. With that in mind, we are now adding an extra savings goal to our budget = new furnace.
The advantage of knowing that something is coming is that we can plan for it.
And remember: an Emergency Fund is for the unexpected that has to be resolved immediately. It’s not for our planned goals or maintenance expenses.
How to stop Raiding your emergency fund
So how do you organize your money to stop raiding your emergency fund?
Raiding your Emergency Fund is a function of TWO things:
1. Your budgeting practices
2. The size of your Emergency Fund
If your budget is based on “best case scenarios” then you are ill-prepared for what life throws at you. You should revisit your numbers and add a category for “home-repairs”, “car-repairs”, or whatever problem you’re raiding your Fund to fix. Add that category into your budget and start saving up money for it. (I’ll talk about this below.)
The size of your Emergency Fund must always be based on the number of Risks you are exposed to.
Dave Ramsey says to start with $1000 and then turn your attention to paying off debt.
And $1000 will work fine…. for some families.
But not all families.
If you have school-age children or own your home then your starter Emergency Fund needs to be bigger to reflect these risks.
So how big does it actually need to be?
Again, this number is going to be a little nebulous. But a good rule of thumb is to start with one month’s worth of expenses. If your expenses are less than $1000 then Wow you win the award for Frugality...!!
... And you should probably have at least $1000 in your fund anyway. ;)
For my family of 7, my grocery bill is nearly $900 every month. By comparison a $1000 Emergency Fund won’t help us much. Our exposure to risk is MUCH greater than $1000 can help us with.
As a result, we like to keep our Fund at a MINIMUM of one month’s of expenses. That’s a minimum, people. Our fund balance is above that number.
I have a fairly high tolerance for risk because of my high Visionary MoneyType. My husband’s risk tolerance is not that high. (You can read more about the quiz I recommend to determine your MoneyType here. It’s totally free. And it will help you understand your money management style more, making couple communication about money easier.)
Once you have this fund complete, you can start Saving above that for goals or maintenance expenses you know are coming. Like my furnace that will likely kick-the-bucket in short-order.
Or if you know you need to replace a vehicle in a few years, or a new roof for your home, or a down payment for a house.
Do you get the picture?
Knowing this about your money management is critical to avoid cycling from one emergency to the next. After all, you WANT to achieve your financial goals. You WANT to achieve stability and prosperity!
And if you’ve been unknowingly sabotaging your goals because of “best-case-scenario” budgeting, then “Shake it off”, forgive yourself, and start calculating your budget more realistically.
You are FREE from Murphy!!
The nice thing about planning your Emergency Fund this way is that suddenly you don’t seem to have as many emergencies! And because of that you have the breathing space to focus on other financial goals besides just refilling the Emergency pot.
Murphy appears to have moved out of the spare bedroom and taken his mini-fridge with him. Hasta la vista, baby!