Monday, July 27, 2009

What Emergency Funds are For

You probably already know what an emergency fund is and why you should have one. In case you don’t, check out this great summary from J.D. at Get Rich Slowly.

Today I want to discuss in detail what constitutes an emergency! Some examples of what does not constitute an emergency?

Broken TV
Weekend invitation to the Hamptons
Cousin’s bridal shower

Obviously, you have to determine for yourself what you consider a real emergency. But here are the emergencies most financial gurus think justify drawing from this fund:

Unemployment. Suze Orman says you need to save 1 year’s worth of expenses in a down economy because it’s more likely you’ll lose your job, and that it’ll take longer to find a new one. I think a full year is excessive, so I’ve saved 6 months’ worth of expenses—including an extra $200 per month for health insurance (I used Healthy NY). This is money that will keep you fed and housed while you’re searching for a new job—unemployment isn’t going to cut it, let me assure you.

Medical emergencies. I don’t think I need to go into detail on this one; use your imagination. But realize that there are lots of things that might prevent you from getting treatment in a medical emergency: say the hospital or insurance company decides it’s a non-essential treatment so you have to pay the whole thing yourself. Say you have insurance but you have to pay hundreds of dollars for drug copayments. What can happen in this case is that you either max out your credit card or ignore the bills, which gets you into tremendous debt and destroys your financial history. Or you don’t get the treatment at all. Dental emergencies fall in this category, too.

Bad luck: a fire or flood tears through your apartment and you don’t have renter’s insurance (who does?), so you have to replace everything. Or your car breaks down, if you use a car to get to work. Or your wallet or purse is stolen. Or your computer breaks down, and you absolutely, positively have no alternative and must replace it before you have time to save up money to do so. (I think a computer and a cell phone are the only electronics that should be replaced from an emergency fund!!)

The unexpected: Maybe you’ll go on vacation, miss your flight home, and get stranded in a third world country. I don’t know. Maybe you’ll get conned out of your monthly paycheck and need to make this month’s rent. Your emergency fund is for whenever you can’t pay for NECESSITIES—that shouldn’t be often. Even when I lost my job, I was able to get by on severance and unemployment money, preserving my emergency fund. Your goal is to save up the emergency fund and then forget about it until you find yourself facing starvation or homelessness. And then it’ll save you.

So if you don’t have an emergency fund, please start saving. Evaluate your own situation: if you feel secure in your job and invincibly healthy, maybe you’ll decide you can save at a slower pace. Or maybe you know that if you did lose your job you’d have nothing and no one else to fall back on, so you’ll choose to start saving 10% of your take-home pay. It’s up to you, but whatever you choose, please don’t put it off!!

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