We’ve all heard the financial gurus out there telling us we need 3 – 6 months worth of expenses, 8 months worth of expenses, and even up to 2 full years worth of expenses sitting in a safe, accessible account in the event of an emergency. I’d like to dissect this advice a bit and get to the bottom of where it comes from and why you should or shouldn’t follow it.
You NEED An Emergency Fund!
The #1 rule of personal finance is that you NEED an emergency fund. The question then becomes, how much of an emergency fund do you need? Let’s first be clear about what an emergency fund actually is. An emergency fund is not intended to replace your monthly income – rather, an emergency fund is meant to cover your monthly expenses in case of, well, an emergency. Monthly expenses and monthly income can be vastly different – and hopefully are in your case. The bigger gap you have between income and expenses, the more wiggle room you have in your budget and the more easily you can handle unexpected expenses and sock money away into an emergency fund.
What Is Not An Emergency
Before tapping an emergency fund, you must first understand WHAT constitutes as an emergency. Occasional expenses like insurance premiums, car inspection costs, vet bills, and home/car repairs/maintenance are not generally considered emergencies because they’re predictable. Ideally, financial gurus will recommend having a separate account set aside to cover the occasional yet predictable expenses like insurances and maintenance, assuming you cannot cover them with monthly cash flow.
The following is a list of items that definitely do NOT qualify as emergencies – regardless of who you ask.
Basically, if you need to tap your emergency fund to purchase any item below – you can’t afford it.
- Buying the latest fashions to adorn your pampered butt
- Jet setting to the Caribbean for a vacation
- Dinner and drinks with friends
- A new car
- A newer car
- A house
- A bigger house
- Furnishings for your apartment or house
- The latest iAnything
What Is An Emergency
The following list is comprised of full-blown, four-alarm emergencies, as well as the smaller stuff that still falls within the umbrella.
- You lost your job and need to pay your living expenses until you find a new one
- Cable – No. Cut the cable.
- You develop a medical condition and require treatment
- You are in a car accident and need to pay deductibles and repairs
- Major home repairs – some argue these are occasional/predictable and not emergencies – I think they can fall into either category.
Reasons To Not Have An Emergency Fund
- You’re not responsible for other people
- You could easily and quickly replace your current income
- You still live with your parents with no monthly expenses
Side Note: You must fall within All of the Above to qualify for not having an emergency fund.
We Err On The Side Of Caution
In case you’re wondering, Mr. MMM and I cast our vote for somewhere South of Awesome for emergency funds. I don’t think anyone will argue that emergency funds are for suckers per se; the issue of how much and where to stash the extra cash is the Great Debate. Having a fully-funded emergency fund sitting in a low interest-bearing account is painful for some people. For some, it’s preferable to have fewer dollars stashed in such an account and access to a much larger invested stash, should a major emergency occur.
We err on the side of caution with our emergency fund. Our cash reserves equal substantially less than 2 years worth of income, however, we’re fortunate enough to be able to cash flow most small emergencies with our monthly income. For the bigger stuff, we sit on the lower side of the recommendations, with that money in an easily accessible money market account.
We also have a few big wins in our corner – One being that I would be able to replace my income fairly quickly if I were to face a job loss. We’re total DIKs and live on only one income. And, we have a sizable amount of money invested in taxable accounts that we could liquidate in the event of a catastrophe. Fingers crossed!
What do ya’ll think? Do you have an emergency fund that could float you for 3 months, 6 months, 8 months, or a year or more? Do you think a big emergency fund is necessary? How do you handle unexpected expenses?
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Feature Image: Jason Droege Photography (jd_visualz on Instagram) – Stunning natural photographs of Lancaster County.