How To Know When To Use Your Emergency Fund
Not all expenses are an emergency. Ask yourself these questions before you spend your emergency fund.
One of the more popular personal finance debates is the importance of an emergency fund.
Personal finance writers and enthusiasts alike seem to agree that an emergency fund is an essential component of a good financial plan, and since the pandemic hit, have changed their thoughts on how much we should have saved. Many now say that three to six months of expenses isn’t enough and are advising people to save six to twelve months. However, according to a June 2022 survey by Bankrate.com, 23% of Americans do not have an emergency fund at all. Only 27% reported having enough savings to cover at least six months.
Greg McBride, a chief financial analyst with Bankrate.com stated, “Inflation, at the highest levels in 40 years, will erode the comfort level with and buying power of your emergency savings.” Paying close attention to how you use your emergency fund may be more important now than ever.
The purpose of an emergency fund is to enable a person to get through financial emergencies without incurring debt. An issue that hasn’t been discussed is how to determine what type of event justifies using the emergency fund. There are certain questions you should ask yourself before you spend your emergency fund.
Is the “emergency” a want or a need?
A lot of people cannot draw the line between something that is required and something that is desired. If you are in need of funds for a medical procedure, then you have a need that qualifies as an emergency. On the other hand, a new iPad is a want that is not worthy of your emergency fund.
Was the “emergency” expected and you had a long time to prepare?
If so, don’t dip into your emergency fund. Take, for instance, that you are throwing a birthday party. You knew in advance and you could have planned for it. Do not dip into your emergency fund for that purpose, as it is unwise.
Is the “emergency” urgent?
I understand that a faulty car may require your emergency fund. You need to get to work. On the other hand, buying floor mats for the car wouldn’t qualify.
Can you defer payment for that “emergency” or pay in installments?
If your heat pump breaks down in winter, it is an emergency, but many companies will let you pay over a number of months. If they’re not charging you interest, it is better to make payments as compared to hitting your emergency fund.
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Does the “emergency” bear financial or other severe consequences?
An unrepaired leaky roof will lead to more expensive damage to your home. Not spending a dollar now will cost many dollars later.
Finally, the argument of Professor Harold Pollack, a University of Chicago Professor and co-author of the book The Index Card: Why Personal Finance Doesn’t Have to Be Complicated summed it up when he said, “You should spend your emergency fund if spending it would leave you in a better overall financial position.”
Build an Emergency Fund
With these simple tips and tools, you can build an emergency fund, even while living paycheck to paycheck.
Reviewed January 2023
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