Featured, Frugality

Emergency Funds Are the Coolest

Bad planning does not constitute an emergency plan.

As per my family’s commitment to live debt free for the purpose of changing the world we have set up an emergency fund. This fund currently contains just about three months of our household expenses, including the amount that we save each month for our irregular expenses. It sits in neat piles of $20 bills in our bank which we can access over this thing that I heard about from a friend called the Internet. If you haven’t heard about it yet you really need to get a clue. Its the next big thing. Right now this little fund earns us $264 a year in interest at the current rate of 4% APY from the troubled and plummeting Washington Mutual (WM). If the Fed keeps cutting rates then this number is going to drop, but I don’t have an emergency fund to make money. I have an emergency fund to handle emergencies.

I have only been alive for 25 short years but already I am old enough to know that emergencies happen. Cars break down, kids break arms, jobs get lost, plumbing leaks, houses need repairing, parents need taking care of … the list of possible circumstances that can generate massive expenses or totally kill your earning power is potentially endless. An emergency fund will give you breathing room to handle the ups and down of life without having to go into debt or liquidate your portfolio. Both can really eat into your earning power and we want to avoid that at all costs:

There are differing suggestions from people that know that they are talking about for the size of a family’s emergency fund. I don’t know what might be best for somebody else, but these are the things that influenced our decision to choose to have a fund worth 6 months of our expenses:

  • We are naturally conservative people – both my wife and I like to know that if something serious were to happen that the last thing we would have to think about would be money. In fact, we want to feel good in those moments of extreme stress, knowing that we already have this expense covered. We can focus on fixing the crisis at hand without worrying about how it will affect our bottom line.
  • Six months offers a lot of flexibility – having such a large sum of cash ($13,200 at current spending levels) readily available will allow us to take advantage of certain financial opportunities that would have other wise been unavailable to us. A good investment, a rock bottom deal on an item that we just started saving for, or an opportunity to pick up and move to a better job and cheaper housing could pop up at unexpected times, leaving us unprepared to take advantage of these opportunities. Having the emergency fund lets us make decisions on our terms rather than letting money dictate our circumstances.
  • The economy is turning, increasing potential for layoffs – who knows how much longer I will be gainfully employed? There is no guarantee that anyone’s job will be there tomorrow so it really is a good idea to ensure that your family will eat, will have a place to sleep, and that you will be able to spend time searching for a good job without the added worry that if you don’t find one soon you will be forced to work the graveyard shift at a 24 hour Starbucks.
  • We’ve got to move sometime – rent in our 1 bedroom San Diego apartment currently represents about 40% of what we spend each month. While it only accounts for about 25% of our take home pay, I would love to kick this number down a couple notches and enable us to get some more money into savings and other investments. It may even be nice to turn our rent payment into a mortgage payment, but that may be a little while down the road still. That is where the emergency fund will shine for us. It could help cover unforeseen costs associated with buying a home or even help us handle our first big home repair if it comes quickly on the heels of our purchase. That way we won’t be saddled with our mortgage payment and a credit card payment to boot.
  • $13,200 seems like it can cover a lot of different catastrophes and even two or three catastrophes at the same time – sometimes a lot of bad things can happen at the exact same time. If our emergency fund were not able to handle multiple predicaments simultaneously we could be hurtin’ for certain.

An emergency fund is an essential part to a healthy and robust financial plan. Without one you run the risk of being the victim of circumstance and poor planning. While an emergency fund does not in any way guarantee security or financial health, it can go a long way in helping you avoid debt and let you focus on handling the human crisis without having to worry about how you are going to pay for it.