Importance Of An Emergency Fund

Disasters strike when you least expect them. Financial disasters are no different: You lose your seemingly stable job; your car needs a new transmission; an extra crunchy tortilla chip takes out half a molar.

But a financial disaster doesn’t have to be an all-out disaster – if you have an emergency fund. An emergency fund is generally three to six months of expenses set aside in an easily accessible account. You simply withdraw the money you need from your emergency fund, and life goes on.

Many People Are Unprepared For Financial Disasters

If this scenario is more fantasy than reality, you’re not alone. A 2010 Financial Literacy survey by the National Foundation for Credit Counseling found that 30 percent of American adults – more than 68 million people – have no savings. One in four adults said they would incur debt in the event of a financial emergency, either by charging an unexpected expense on their credit card or taking out a loan. One in five would end up neglecting financial obligations.

But the consequences of being unprepared for a financial disaster can be serious and long-lasting.

For instance, if you lost your job tomorrow, what would you do? How would you pay for basic living expenses? If your plan for any disaster is to charge your troubles away, you could end up deeper in debt. And that’s only if a credit card is a possible solution to your problem. If you typically carry a balance, your credit limit may not provide you with the amount of money you need. Or a credit card may not be an acceptable payment method, causing you to take out a cash advance. Borrowing money in this way is costly, since the interest rate for a cash advance is typically higher than what you’re assessed for purchases.

Ignoring bills that come due – which the Financial Literacy survey found was another popular alternative to an emergency savings fund – is a surefire way to damage your credit and lower your credit score. Rebuilding credit can be a difficult and lengthy endeavor.

Plus, not paying your rent could cause eviction, and if you default on your mortgage, you could face foreclosure.

Save For A Rainy Day

Really, the simplest solution is to follow the popular old adage: Save for a rainy day.

Building an emergency fund will require time and diligence. But your efforts will pay off when you successfully maneuver through a financial disaster.

But what specifically is a financial disaster? Typically, it’s an event that threatens to compromise your personal financial security, and causes you to accumulate debt. Common financial emergencies include:

• A job loss
• A medical emergency
• An automobile repair
• A home repair

For example, if you suddenly find yourself out of work, you’d want to dip into your emergency fund to meet monthly expenses – not pull out your credit card for basic expenses like utilities and groceries. That said, you’d also want to be sure to use your emergency fund only for necessities, and to cut back on luxuries that you can do without when times are tight.

An Emergency Fund Is Only For Emergencies

Still, defining the term “emergency” can be confusing. If you’re a homeowner, an emergency home repair would fix an issue with serious consequences for your well-being or the well-being of your house. Fixing or replacing a malfunctioning furnace in the dead of winter or a leaky roof falls into this category, whereas renovating a kitchen or a bathroom does not.

The same holds true for medical emergencies. Studies have found that serious illnesses can cost families thousands of dollars a year. Even an unexpected surgery, a trip to the emergency room, or a dental mishap shouldn’t put you in debt if you have an emergency fund.

You may be tempted to withdraw money from your emergency fund if the account has remained untouched. After all, three to six months of expenses can be a substantial amount of money, and you may think that it could be put to better use elsewhere. But no one hopes or plans for an emergency: They happen when you least expect them.

Also, there are many items and circumstances in our lives that we consider needs, when they are actually only wants:

• Vacations
• A new car
• A home renovation

While wants are important, they’re simply not emergencies. You may certainly save for wants such as these, but it’s not advisable to dip into your emergency fund to pay for them.

Deciding in advance what constitutes an emergency may perhaps be the best way to handle situations or temptations that may arise. After all, wouldn’t it be unfortunate to find your emergency fund depleted when an actual emergency comes along?