You can’t read any basic financial advice without reviewing the importance of building an emergency fund. And that’s for a good reason.
This savings account that you keep separate from everything else protects you against unexpected events that require more cash from you than you may have in your monthly budget.
We can’t know exactly what will happen in the future. But we can plan for it by knowing these emergencies will pop up. Don’t think of it as a matter of if it will happen, but when.
Creating your emergency fund is the obvious first step toward planning for these random and sometimes costly events.
And it’s pretty easy, too. You steadily save money in this account, month after month, until you have three to six months’ worth of expenses in the bank.
The question that’s not so easily answered is knowing when you should use your emergency fund.
What’s the true purpose of an emergency fund?
Funds in this savings account should cover true emergencies, those moments where you don’t have a choice about whether you will or will not spend the money. It is not a slush fund for you to dip into whenever you want to buy something you otherwise can’t afford.
An emergency fund is also not a savings account that you can use to fund other goals when you get impatient with your progress.
However, you may still be unclear as to what constitutes as a true emergency. Essentially, you must learn the difference between a legitimate reason to break into your emergency fund, and a situation that just sort of sucks.
Therefore, ask yourself the following four questions to help you decide when you should use your emergency funds and when you should find other solutions instead.
1. Do you need to pay for it right now?
You should use your emergency fund when you absolutely need to pay for something. If you simply want something, then it’s not an emergency.
Getting your car towed to a mechanic when it breaks down on the side of the road is something you need to do. Especially since you’re likely to pay anywhere from $35 to about $300 to go 50 miles or less.
Meanwhile, a car repair might cost you around $1,000, putting your total expenses in the ballpark of around $1,500. It’s understandable if you don’t have this amount of money available in your monthly budget.
That’s why using your emergency fund to cover these expenses without charging it to your credit card (and potentially racking up debt) makes more sense.
On the other hand, buying a new car because yours is ugly and you’re tired of driving something old is a want. Wants do not warrant a use of your emergency savings.
What’s more, the average transaction price for light vehicles in the U.S. is just under $34,000 (and that’s not including interest on the car loan if you finance).
Therefore, repairing your car is probably a lot cheaper than buying a new one anyway.
2. Can you use other means to pay?
Your emergency fund is there for you when everything else fails. It shouldn’t be your first line of defense.
Let’s say you get an unexpected big medical bill in the mail of $500.
Do you have a line item in your budget for entertainment and dining out that totals $200? And $300 in a travel fund or some other account for a short-term spending goal? If so, consider reducing that discretionary spending to cover the required medical bill instead.
When you can afford to cover an expense with your monthly cash flow, do it. You just may need to cut back in other areas and go out a little less until next month. But this makes more financial sense in the long-run.
When all’s said and done, don’t draw from your emergency fund if you have the cash on hand to pay for the expense outright.
3. Do you need to make a decision right now?
It’s hard to think rationally when you’re faced with an urgent decision. Especially if that decision is not only a time-sensitive one but an emotional one as well.
When your sick pet is at the vet, for example, that’s not the time you want to crunch the numbers and decide what kind of care they’ll receive based on what’s left in your budget for the vet bill.
In urgent, high-pressure situations, it may make sense to pull the money from your emergency account instead. You can pay for the cost immediately then figure out the financial logistics later.
Later on, you can sit down to review your overall budget and decide how you want to allocate the cash you do have towards the unexpected expense. You may ultimately decide to pay for some of it with money from your budget and the rest from what you saved.
Say the total bill was $1,000. You could use some discretionary line items from your spending for the rest of the month — like meals out, events, or extra travel — to put $300 from your cash flow to cover the expense.
Or, you may decide to keep a small balance of $300 or so on your credit card for now if you prefer to pay the interest rather than disrupt your cash flow.
Then, you’ll only need to pull the other $700 from your emergency fund rather than taking the full $1,000 out of it.
4. Is the cost temporary?
Another factor to consider when determining if you should use your emergency account is whether or not the cost you’re trying to cover is a one-time issue that’s quickly resolved. Or, if it’s an ongoing problem.
Say you just bought a computer for work. You saved up the money for months because you couldn’t afford it outright. And then someone breaks into your car a few weeks later and steals it.
You need the computer to do work, but you don’t have the cash flow to buy another — so dipping into your emergency fund to replace it might make sense.
But what if you lost your job altogether and had no source of income? Your living expenses become costs you need to cover until you locate a new source of earnings.
That could take weeks, months, or even longer. So your emergency fund may provide temporary relief for a week or a month. But it won’t last forever.
Before you use your savings, you need to make a plan for making the most of the funds you do have, so you don’t run out before your problem is solved.
You used your emergency funds: now what?
Just as important as asking when should you use your emergency fund is asking how you’ll rebuild it once you do.
If your rainy-day savings account was full before an unexpected expense caused you to dip into it, you might not have been actively contributing to it. Your first step is to determine how much you can afford to contribute to the fund each month.
You don’t have to replenish your emergency savings right away. You probably didn’t start with a fully-funded account, and you don’t need to immediately get back to full capacity either.
Instead, choose a small amount to transfer to your savings. That could be $25, $50, or $100. Maybe even more, depending on your cash flow.
Then, set an automatic transfer from your checking to savings account, so you consistently replace the money you needed to use to cover your financial emergency.
If you receive any kind of windfall, like a cash gift, bonus, or inheritance, use this to finish rebuilding your emergency fund. Or at least, take half of the gifts, bonuses, and other amounts of cash you receive outside of your normal earnings and put it in your savings.
You can also try to build up the fund faster by working a little overtime. Or by picking up the pace on your side hustle if you have one.
At the end of the day, every little bit helps. And what’s important is not how fast you replace the money that you took out of the account, but that you actually do so over time.
Once you’ve used an emergency fund, you know how critical it is to have one. So make sure you’re caught without one in the future!
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