Don’t touch your emergency fund, unless you are truly having an emergency!
The M-Network is currently doing a series highlighting Dave Ramsey’s 7 Baby Steps for getting out of debt and getting your life on the right track financially. You can read about all of the steps over on Cash Money Life who kicked things off with a great introduction. As other members of the network add their articles, I’ll add them to the end of this post.
The third step in Dave Ramsey’s plan for getting your financial life in shape is a fully funded emergency fund. The definition of a fully funded emergency fund is 3 to 6 months worth of expenses in an easily accessible account.
Why Do You Need a Full Emergency Fund?
Some people believe that having a small emergency fund of $1000 or so is enough, as long as they have assets like a 401k to tap into if they run into trouble. The problem with that way of thinking is that a 401k isn’t easy to access in a true emergency.
My family found out about the importance of a large emergency fund last year when my husband lost his job. Twice. We had about 1 month worth of expenses in our emergency fund, so money was really tight. In addition, my husband had to take some less than ideal jobs to make sure we had food on the table.
When you have 3 to 6 months of expenses tucked away, you have the freedom to wait for a good job. You have the freedom to quit a job that’s sucking the life out of you, because you know you can survive until you find a new one. You have the security of knowing you can pay high deductibles for medical issues if the need arises.
You don’t want to be tapping into your 401k to pay for an unexpected surgery or hospital stay.
What is a Fully Funded Emergency Fund?
It’s not 3 to 6 months of your salary. It’s 3 to 6 months of expenses. When you lose your job or come up against another kind of emergency, you should be able to cut a lot of expenses from your monthly budget.
If you bring home $5000 a month, but can live on $3000, then use $3000 a month as a basis for determining the amount of your emergency fund.
Deciding whether to fund your emergency fund for three months, six months, or somewhere in between can get tricky. If you’re a single person with no children, a stable job, and a rented apartment, you’re probably safe with three months worth of expenses.
If you’re the sole breadwinner for a family of four, with a mortgage and an unstable job in sales, you’re going to want to have six months of expenses in the bank. Trust me on this one.
Where Should You Park Your Emergency Fund?
You want your emergency fund to be easily accessible. I prefer to keep my emergency fund in my ING savings account. It fetches a decent interest rate, and I have it attached to my ING checking account for easy access via a quick transfer on the computer and an ATM card.
Dave Ramsey suggests keeping your emergency fund in a Money Market Account, which would also be acceptable. The main point is that your money should be accessible to you as soon as you need it, without penalty.
Though some people suggest that using a HELOC for an emergency fund is a good idea, I don’t like it. When you’re in the midst of an emergency, I don’t like the idea of taking on more debt. I also think that it’s psychologically more difficult to spend cash that you’ve worked really hard to save, rather than a line of credit, where all you have to do is sign on the dotted line. And that’s a good thing when you don’t have a large cash flow.
You don’t want to look at your emergency fund as an endless supply of cash for your need to redecorate the house. You want your attitude to be one of hating to spend the money in any event, but a true emergency.
What Constitutes an Emergency?
Well, it’s not a new flat screen TV. And it’s not a new wardrobe, because your old wardrobe is out of style. And it’s not a $1000 stroller for your baby.
A true emergency is something that interferes with your life, your health, or your ability to pay the bills. Hospital stays, disability, and loss of a job are all true emergencies.
If you aren’t having a true emergency, DON’T TOUCH YOUR EMERGENCY FUND!!!
Here are all of the articles thus far from the M-Network series:
- Overview at Cash Money Life
- Step 0 – No More Debt at Debt Free Revolution and Single Guy Money
- Step 1 – $1000.00 Emergency Fund at Gather Little By Little
- Step 2 – Pay off all debt using the Debt Snowball at I’ve Paid For This Twice Already
- Step 3 – 3 to 6 months of expenses in savings right here!
- Step 4 – Invest 15% of household income into Roth IRAs and pre-tax retirement at The Dough Roller
- Step 5 – College funding for children at at My Two Dollars
- Step 6 – Pay off your mortgage at Moolanomy
- Step 7 – Build wealth and give! at Plonkee Money
- Series Wrap Up at I’ve Paid For This Twice Already and Being Frugal
What do you think about emergency funds? Do you have one? How much is enough? Where do you park yours?
Photo by Paul Keleher.
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We have a 3 month emergency fund in an ING account. We also use an ING account to save for planned expenses. Since we are not quite ready to pull the trigger on a bathroom renovation, we have about 6 month’s worth of expenses in cash.
Over the next year, we plan to build up the emergency fund, but need to fully fund our 2008 IRA contributions first.
I am loving this series. I just now reached my €1000 emergency fund target (I just posted how on my blog) and now I’m looking to expand this. The funny thing is that I never realized that the 3-6 months goal was for expenses- I always thought it was for income! Therefore, I’ll be shooting for three months of expenses to be tucked away, as in France there’s a bit more job security than in the US.
Fantastic article (as usual)!
Right now, we’re working on building our emergency fund, and it is also in an ING savings account.
My husband has the main paycheck and I just have random freelance income, so we’re aiming for 5-6 months of expenses. I hope to have that by the end of the summer. Woo hoo!
We just established our EF of 6 months of expenses for our meager little life and are debating where to put it. It’s between ING and a MM account. I was hoping your article would tell me what to do but instead it gave both as viable options. I guess I can’t go wrong.
Thanks for the great article. I’m enjoying the series.
I agree, you lose the point of having the emergency fund, if everything to you is an emergency.
We keep about 5 months of expenses in a money market account, but also have a CD that is like the “break glass in case of emergency” last resort. I would rather pay a fee to cash out a CD, than borrow from 401Ks or take on more debt.
I think it is important that everyone have an emergency fund that they do not touch for random expenses, AND have a smaller savings account for those “special” purchases or vacations. That way, you can save to make your purchases without going into debt AND you will be able to fund your emergency stash.
Take Care
LJ
Until we can save and get out of debt our Home Equity is our emergency account. But in our case we avoid spending money out of it as much as possible. Both of us HATE using it and will avoid it at all costs. It really did save us when our eldest had to be transported to the hospital twice–the ambulance ride alone was over $2000 out of pocket. We do have insurance but it is out of state due to my husband’s employer and doesn’t cover as well.
I agree with your comments regarding protection from job loss. A fully funded emergency fund can keep you afloat until you find a good job, not just any job. It’s the difference in finding yourself in a better employment situation than you were prior to the layoff, or greeting customers at Wal-mart.
What if you don’t want to tap your emergency fund? We had 2 unexpected things happen this month; our pet falling ill (she ended up dying)(around $950) and a broken tooth (will be $1300). However I’ve not used the emergency fund since I’ve created it I’m loathe to touch it, but am also getting anxious how to juggle everything to cover the bills, I’m not sure it’s even possible. My husband thinks that’s what it’s for, but I almost feel like a failure to take the money. What constitutes a real emergency?
@partgypsy – Everyone has different opinions, but I would tap the emergency fund for health related expenses. Ideally, you will eventually set up a sub-account in your checking or savings account for irregular expenses, like medical expenses, home repairs, car repairs, etc. But until then, tapping into your emergency fund is better than going into debt or going without food.
I don’t like the of a HELOC either. You have to have it in place before an emergency (you can’t get one if you don’t have a job!) and then you need even more income to be able to repay the debt. It’s not much better than a regular old credit card, especially since you can get 0% interest on a revolving CC for at least the first 6 months or so.
I think its very important to
1-not use the EF unless its a true emergency
2-USE IT if it is an emergency, that’s what it’s for! (partgypsy, I would consider both of those things emergencies!) Your regular savings & investments in addition to the emergency fund are “safe” to never touch and let them grow (with a higher interest yield!) only if you are really using your emergency fund for emergencies.
Lynnae, Jen, thanks for your feedback. I posted because I realized this resistance to touching the emergency account is causing me stress. For the first emergency we were able to be creative (husband worked a couple extra shifts)to pay it without using our emergency funds (it’s in a money marking checking), the second emergency, just can’t see how we are going to do it. But I need to accept it, be glad we do have the funds for it, and move on.
That is actually my goal for this year, to have 2 months of emergency fund or 3K by the time I relocate in September. Once I relocate, I will be getting into the habit of funding my emergency fund at a more monthly average (250/month versus 375/month right now) so that I can begin 2009 with a routine and reach 4 months by the end of 2009.
You gave me a thought to add the deductibles on top of my expenses because how often is a deductible needed? Not often enough to be an emergency but should be in the account so I will have to raise my bar a little higher.
Thanks a lot for the link.
I’m enjoying this series, especially since I know exactly nothing about Dave Ramsey.
Mike
What constitutes a real emergency?
Something that cannot be payed out of monthly cash flow. If I can pay for it by cranking back on life style for a short time, I will not tap the emergency fund.
Pay the vet and dental bill, even if you have to use the EF. An unpaid bill is a debt, and if you haven’t set up repayment arrangements with the vet and the dentist, those bills are due. So the question is, would you prefer a debt or a paid off bill?
I’d amend susan’s definition of an emergency: an UNEXPECTED event that cannot be paid out of monthly cash flow. What your average medical, dental, veterinary, household, and auto repair “emergencies” are, are usually pretty predictable. Those should be budgeted monthly as a sinking fund so the money is there when the occasional bill/event happens. However, the rare event outside the norm that couldn’t be expected and budgeted for–like the $1300 dental, the $2k ambulance (I’d argue with the insurance company about that one–mine covers out of state emergency situations), the $950 vet bill–those are really unusual events outside the norm that I wouldn’t have budgeted for specifically, in the sinking fund accumulations. Dip into the EF for that but rebuild the EF right away.
Christmas comes every December and is not an emergency. Save for it! LOL
gypsy, I totally understand about not wanting to touch the EF. I’ve piled mine up nicely and it feels like a nice warm security blanket. I know I should pay off my last debt outright with it, but I have grown so attached to that big fat steamin’ pile o’ cash!!!
I just read Dave Ramsey’s total money makeover. I didn’t think I would like it as much as I did. We are doing some, but not all of his advice. For example we have 8K of debt(heloc). He would recommend stopping all contributions to 401K and also emptying all but 1K from emergency account to pay it off. Upon discussion with my spouse, we are more comfortable with: use the EF for the most recent emergency, and continue to pay off this debt at usual pace, and keep contributing to retirement. As we tried to raise money to pay off last emergency without EF, we will instead apply this extra money towards the debt instead.
But overall I think he has alot of good advice.
I have a doubt and have been surfing the net about it… About the full emergency fund. Say is 6 months of expenses… This expenses include basic needs only? or should we include envelopes for say car insurance, oil, repairs, or entertainment, or clothes… I mean… things that I take a little bit every month til they accumulate and then buy… OR should I just include, say MORGAGE, FOOD, GAS, etc, only?
Great article. Emergency funds are so important. Thanks for the clarifications.
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