Emergency Fund: For Emergency Use Only!
Personal finance experts suggest that a person accumulate at least three to six month’s worth of living expenses in a liquid savings account that can be accessed immediately in a time of need—an Emergency Fund. While all agree that an Emergency Fund is necessary, there is little discussion of just what constitutes an emergency.
It is critical to define a true emergency because the Emergency Fund is often exploited to pay for expenses that do not qualify as an emergency within the context of personal finance. Here are some examples:
- An unpredictable expense such as an automobile repair, house repair, medical deductible, or appliance replacement is not an emergency. Unpredictable expenses should be funded, in advance, through regular budget categories.
- An impulse purchase of a big ticket item: a wedding, a vacation trip, Christmas presents, a loan to a family member or friend, an automobile or boat, and so forth is not an emergency. Big ticket purchases should be paid for, in advance, through the use of the budget and a targeted savings account.
- College tuition, capital to start a business, or a down payment on a mortgage is not an emergency. These expenses should be paid for, in advance, through the use of the budget and a targeted savings account.
In the wake of the Great Recession, the true definition of an emergency is painfully clear: A personal financial emergency is an interruption of income. Whether is it due to a layoff, a reduction in hours, a medical problem, a natural disaster or some other calamity, an interruption in income is an emergency. The primary reason for the Emergency Fund is so a person or family can survive an interruption in income without having to take on debt or tap retirement funds.
The suggested three to six month time frame for the Emergency Fund reflected the average time it took to find new employment for someone who had been laid off. Post Great Recession, that time frame has been extended considerably. An Emergency Fund equivalent to six month’s to one year’s worth of living expenses may better suit the new reality.
Are there exceptions to the definition of an emergency? Of course there are exceptions, but they are rare occurrences. For example, air fare and hotel expenses to travel to the funeral of a loved one or close friend who dies suddenly might qualify as an emergency if there is not enough money available in the vacation budget account to cover the cost. Payment for legal representation in the event of a criminal charge or civil lawsuit is another example where the use of the Emergency Fund might be justified.
Whenever the Emergency Fund is drawn upon, it should be replenished as soon as possible.
The Emergency Fund is not a slush fund. It is insurance against the use of debt or retirement savings to bridge an interruption of income. Treat the Emergency Fund with respect, and you can experience sustained freedom from debt and enhanced financial security.
K.C. Knouse is the author of True Prosperity: Your Guide to a Cash-Based Lifestyle, Double-Dome Publications, 224 pages.
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