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money health weekly

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You'll Be Happier with an Emergency Fund


 

"The shortest period of time lies between the minute you put some money away for a rainy day and the unexpected arrival of rain."


-Jane Bryant Quinn

 

It's my senior year of college and my workload is intense. I used to work full time at a bank and go to school full time, but now that I have my plate full with high-level classes, doing research on real estate prices, trying to get published, putting a presentation together, and thinking about what to do when I graduate, I had to let go of some hours at work. 


As a result, money is tight. I have rent to pay, bills coming due, and of course I can't forget to go to Coach's on Thursday for three-for-ones. I'm a college kid, so I know how to prioritize. 


Most of my shortfalls can be put on one of the many credit cards they give you when you are in college. I struggle to figure out how to pay my rent, though. I wonder why I can't manage my money like everyone else can.


More recently, I've come across a statistic that 33% of Americans can't cover an unexpected $500 expense without going into debt, and 66% can't cover $1,000. Then every time I read about a union strike or a government shutdown there are stories about union workers and government employees who are set back by missing even a single paycheck.


I now realize the struggle is real. Many people don't have money set aside for unexpected expenses. So how does the proverbial emergency fund help? 

income uses

The Emergency Fund: Many Definitions


An emergency fund is the general name given to money that is set aside for unexpected expenses. That's it. It's not really a fund, in the real sense of the word. Some people have a savings account with all their savings and the "emergency fund" is part of that bucket of money. Some people have a separate savings account. Some use CDs (although these can't be used very easily for emergencies because they have maturity dates and penalties), and others use money market funds. The point is, when you hear "emergency fund," just know that means a pot of money that is set aside. 


How big does this need to be? Ask five people and you'll get five answers. Some people want you to calculate your basic living expenses and save a set number of months, like covering 6 months of living expenses. Others use 3 or 12 months. Other people will use income instead of expenses - setting aside 6 or 12 months worth of income. Again, the point here is that the number isn't as important as having a cushion. The size could differ, too, based on whether you have a single-income household or a two-income household. 


Besides 1) where to put the money and 2) how much money to have, there is a third consideration. That is, what constitutes an emergency? Some will say the emergency fund should only be used for actual emergencies. By this logic you would use emergency fund money to cover car and house repairs, vet trips, and of course, living expenses if you lose your job or miss a paycheck or two. A competing view is that emergency fund money can be used for anything that is outside of your regular budget; something that is a nonrecurring expense for example. It's common to hear it called something besides an emergency fund, like a rainy day fund, or cash cushion. These folks say that it's okay to use emergency fund money for concert tickets for your favorite band that just announced they are coming to town, a night out with your friend that unexpectedly came to town, or a good deal on that lawnmower you've been thinking about replacing. 


No matter what you call it or how you use it, it's important to have money set aside for when things happen, either bad emergencies or good opportunities.

 

How To


Understand that the lack of a cash cushion is not something that only happens to people in poverty. For some people you're going to have to take a really hard look at your expenses and see where you can cut. For others, you may be stuck in the "Everything Else" category of the first sketch, mindlessly spending your money on things that may not be important to you. 


There are many ways to build up an emergency fund, and there isn't one way that's best for everyone. So if you read about a way to build your savings that works for you, that's awesome and you should do that. If it doesn't resonate with you, find another way. 


Personally, I am all about making things as easy as possible and a part of a process. I am a believer in having savings plan - that is, a plan for how to save your money. This requires some up-front work since you'll have to determine how much you can save (but again, for many people this is higher than they think). Then I would set up a waterfall effect.


For example (see the sketch below for a visual), your first savings might go into your 401(k) so that you get the company match. Once you've contributed that, your next savings would fill up your emergency fund bucket. Once you fill that up to whatever number makes you comfortable, you could start contributing to your health savings account until that is maxed. As your savings goes up your next savings might go into some goal-specific savings, like a travel account or a college savings plan. Then you might want to max out your 401(k) to its limit, and any other savings over that could go into a taxable investment account. The idea is that you set up the process once, and then you just follow your process. 

savings flow

The exact buckets and the order will differ based on your needs and comfort levels; this is just an example. You might not have a health savings account and you might want to split your last savings between goal-specific and maxing our your 401(k). Another caveat here is that these could be separate accounts, or some of these buckets could be the same savings account. The specifics will depend on your situation. The real goal here is to get y