What is an Emergency Fund?
Investopedia.com define it as follows:
Emergency Fund – An account that is used to set aside funds to be used in an emergency, such as the loss of a job, an illness or a major expense. The purpose of the fund is to improve financial security by creating a safety net of funds that can be used to meet emergency expenses as well as reduce the need to use high interest debt, such as credit cards, as a last resort.
We hear a lot about saving for an Emergency Fund these days, but rarely hear ways to help those who are struggling with periodic dips into their EF for non-emergency reasons! If that is what you need… today is your lucky day!
When my wife & I started really working hard to cut our expenses and begin saving, one of the first pieces of advice we kept hearing about was to build an initial emergency fund of $1,000… so we did. What we failed to understand was that it was only for emergencies! Go figure right. After just one or two months of creating the Emergency Fund, we had already dipped into it several times.
You know the story. Couple gets in debt. Couple finally realizes they are in debt. Couple creates budget, begins cutting costs, & establishes very first Emergency Fund. All solid stuff… but because they are new to the whole budgeting thing, the couple’s new budget is still virgin & not fully formed. Therefore, it may not be long before variable, irregular, & other costs — forgotten on the initial budget — begin popping up like crazy, thus overextending their budding budget… and into the Emergency Fund they go! It’s all too familiar…
So What’s The Answer?
Okay… so we should form an Emergency Fund. Got it. But how do we keep from dipping into it?
6 strategies to help you save your Emergency Fund for the true emergencies
1. Define what an emergency is to you
Defining a few concrete reasons why & only why you can access the money may be one of the best strategies around. Taking this step will set boundaries that will either have to be followed or broken… it always helps to set boundaries for proper financial behavior. For my wife & I, an EF withdrawl can only occur in the event of a job loss or health issue. We also established a clause that allows us to discuss spontaneous matters, run them against our priorities, and determine if it is indeed worthy of our EF money.
2. Reserve a large initial amount for miscellaneous
For the first few months while you are forming & tweaking your budget, trying to remember all the little expenses off the top of your head is something that should be reserved for 12 year old geniuses and Jeopardy contestants. Since most of us are neither, it is a good idea to give ourselves some leeway until we get a few months of successful budget tweaking under our belts & have a better feel for what our true budget really is. Looking back, it would have been nice if me & my wife would have allotted between $300 – $500 per month for misc.
3. Keep a spending journal
You may think this is silly, or tedious… but it is really simple and is essential to really nailing down your budget. If you are not fully aware of precisely where your money is going, you will not be able to budget effectively, and hence… will not be able to save any money! Carry this spending journal with you at all times so you can record every penny spent for at least one month (I recommend at least 3 months of record keeping, but 6 is best). Always carrying the journal with you will also help you be able to write down varying expenses as they pop into your mind. You can
4. Thoroughly & continually develop your budget
Perhaps the most common reason people dip into their emergency fund for non-emergency situations is because they forget to add all the expenses to their budget. Many of us have a lot of little expenses that we do not normally have to deal with on a month to month basis — therefore they often slip our mind. Here are some expenses that people often leave off their budget and end up dipping into the EF for:
Regular expenses – auto & life insurance, charitable donations
Irregular expenses – auto maintenance, license plate renewal & auto registration, gifts, medical costs
Variable costs – haircuts, gasoline, household items, bank fees, professional dues, dry cleaning
5. Sacrifice things instead of dipping
Chances are you may be dipping into your EF for something that is not totally necessary. To combat this you can sacrifice something for the cause. I ALWAYS suggest you cancel your TV service, which normally saves the average family between $60 – $140 per month! What other expenses can you cut in order to preserve your EF?
Going out to eat – this was the big one for us, we stopped eating out & are saving around $5,000 yearly
Clothes shopping – chances are you have WAY too many clothes in your closet anyway… c’mon, you know I’m right!
Movies – instead of going to the theater, we just wait for movies to be released on DVD and order via Netflix
Cell phone – lower your cell phone minutes down and begin using Skype over your Internet connection
Eat more beans – we cut over $100 per month from our grocery bill by eating less meat & more beans (ps… this helped us lose weight & is giving us better health)
6. Be Creative to find other ways to avoid dipping – Here are a few creative ways to keep you from dipping into your EF:
Can you ride your bike to work a few days a week to save some money?
Make your EF hard to access. Put it into a bank account that is not easily accessible – give the money to a trusted parent, spouse, sibling, or friend to hold onto for you until you fully develop your budget & discipline. Tell them that you can only request the money for the limited reasons you established in step 1 above.
I wish someone would have given me & my wife this list of tips when we first started saving for our Emergency Fund! We hope this helps you keep your hands out of the cookie jar!
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I think miscellaneous expenses are the biggest reason budgets fail at early stage and people turn into their EF….you have to remember that it will take some time to get your budgeting right and always leave room for error. Emergency Fund should be only for emergencies….like dave ramsey says give it at least 24 hours of thought before you dip into it.
Thanks for the post. Dipping into the EF is a big temptation and one that is also very demotivating. One dip may wipe out months worth of work to get it in there and seeing the new lower balance after you’ve dipped may discourage you to a point of giving up.
Your spending journal idea I think is one of the greatest eye-opening experiences one can do with their financial situation. There is something powerful about seeing your expenses add up on paper. I highly suggest it!
Keeping a journal is such an easy step too! I didn’t even mention discouragement in this post… great point, thanks for bringing that up Jason.
One thing we do to make sure that we don’t dip into our emergency fund is that we keep it completely separate from all of our other accounts. As the saying goes, “out of sight, out of mind”. When the money isn’t readily available, it makes it easier to not spend it – at least for us. Then we just budget for all the other miscellaneous and irregular expenses, and then they don’t come as a surprise – and we don’t need to dip!
Excellent… this is a GREAT example of point number 6! Thanks for sharing Pete.
This is exactly what we do! It came in extremely useful when we had to pay a lot into taxes in April. We were surprised by how much it had grown since we last looked it it and the EF kept us from having to pay our taxes on a credit card.
I have a hard time using our EF since I am more likely to sacrifice something than dip. I guess that’s good but it seems like I would benefit from defining emergencies.
Great article and really good advice, thanks.
Although you hit upon some excellent points, I think that you overlooked a very important and very obvious one, in all due respect…
The best way to handle an emergency fund, no matter how big or how small, is to have an actual, real-life emergency. A well-controlled fire, a small flood caused by drilling a hole in a water heater, or a moderate, single-car, car accident (well planned so as to not inflict any bodily harm) are all great examples of very valid ways to spend an emergency fund.
Every year, my neighbors and I take turns, coming up with the best ways to spend our emergency fund. All of the above ways, and more, we have used over the years. It’s great and it’s a lot of fun, carefully planning and executing our “emergency”.
Trust me, nothing beats a real emergency for an innocent and worthwhile way to spend your emergency fund. The first time you experience the thrill of being involved in an emergency (one that you planned from scratch), you will wonder why you did not do it years ago.
For those of you who think I am joking, rest assured that I am 100% serious. Ask around and you will find that there are MANY people like me, who agree that the perfect way to spend an emergency fund is exactly as it is intended–by creating a real emergency.
Oh my word… lol! Awesome comment Dave.
I’m sure you have fun doing this, but it is not something I would advise my readers to partake in! 🙂
Matt, I want to thank you for backing up your ideas with practical suggestions on how to carry them out. That is what I like most about your blog. I am planning on working on my budget today. I started it using Google Docs, a suggestion I also found on your blog. You are doing some good work here!
Thank you for the encouragement!
I try not to suggest anything unless I have tried & tested it in my own life. Otherwise my words are nothing more than sounding brass or a tinkling cymbal! 😉
Good luck on your budget… make sure you follow through on keeping it – it is paramount to personal financial success!
We have our emergency/the AC’s gonna go any day fund in a separate high-yield savings account. We’ve had a few things that we decided would be OK to cover out of that fund, and after all the bills were paid, things were tight, but we realized we didn’t need to move money over after all.
That said, when we *did* have an emergency (I was out of work for 6 months for cancer), it was hard to see the fund deplete.
I’m sorry to hear about your cancer H Lee D, but I am happy to hear that you had your Emergency Fund in place! 🙂
I haven’t had to watch my EF empty yet… I bet that can be a little discouraging, even if the cause is utterly necessary as in your case.
Per your cancer, check out – The Gerson Therapy?
I had heard of it (though not by name) via a man who pestered me at the gym a couple of months ago. It would not have helped with my cancer treatment, as by the time there were symptoms, I was pretty close to suffocating (it caused fluid to build up around my lungs — they took 2 liters out of the right side only, and another 1.5 liters a week later, and I’m 5’4″). It does look interesting for regular daily healthy living, though.
Nice topic… Emergency Funds can easily become a roving budget extension rather than a true source of funds for when emergencies strike.
I like the idea of making the money ‘hard’ to access. We still want a high degree of liquidity and we don’t want to jeopardize the funds but it’s kinda like the fire extinguisher behind the plate of glass. Accessible when needed but more trouble to access for goofing around with.
1 thing each that I’ve done and plan to do are this:
Earlier this year (prior to April 15) I parked 10k as my 2008 Roth IRA contribution (technically my wife’s and mine). I did not release these funds into the market and I can pull them back out at any time with a call to my broker. It would take about 3 days to get the money which is a short enough window. I’ve also made my 2008 contributions before that window closes forever. I’ve written about this a couple times if you’re interested in checking it out.
Second, is a CD ladder. I’m drafting an outline for an article on this too, but the idea is to have CD’s coming due each month with enough to sustain that month in the event of an emergency. The funds are available but not immediately so… out of sight out of mind.
Hey, thanks for sharing on this great topic.
Dave
Great post! I just wrote an article on what qualifies as an emergency on my blog, so I’ve been thinking about this topic. I particularly like your first idea, that of defining in advance what an emergency is–my only qualm is that an emergency fund is for the unexpected, too. In any case, I may go back to my post and add in a link to this one. Nice job!
Thank you!
It’s interesting to hear about the ‘evolution’ of your budget and emergency fund.
I think one problem people run into with new budgets is making them too tight so there is no room for error. This could result from necessity (ie not enough money) or just optimism since it can be “fun” to watch your debts go down. As a result they often have to dip into the EF because they run out of cash frequently.
I don’t have any magic solutions other than to suggest some of the following ideas:
1) If possible then either loosen the budget or cut spending more to create some extra money to handle extra costs.
2) Reduce debt payments a bit to free up more cash.
3) If 1 and 2 aren’t an option then maybe consider treating the EF as an “overflow” fund until you get to the point where it can be a real EF.
These ideas kind of go against the “gazelle intensity” train of thought but sometimes you have to look at the reality of living and adjust accordingly.
I agree 100% that creating an initial budget creates a feeling of elation that often causes the creator to over-extend their income. Most times people will forget at least a couple expenses, so it is challenging to take the hurdles in stride and remain in high spirits. We just have to adjust accordingly and proceed… enthusiasm in tact.
Excellent suggestions… I have adopted parts of each.
It helps to consider EF as “zero”, as if the account does not exist; thinking that way helps you somehow to not dip into the fund.