Making It Through Money Emergencies

February 28th, 2008 | by rachel |

Money emergencies are inevitable!  They occur at inconvenient times; they cause frustration and anxiety; and they are detrimental to budgets, especially tight ones.  Unfortunately, many people are unprepared to handle money emergencies without accumulating additional debt and/or risking long-term investments.   While it is impossible to stop money emergencies from happening, it is very possible to minimize their effects.  An “emergency fund”, sometimes referred to as “rainy day funds” or “non-retirement savings”, will provide peace of mind, time and choices for making it through all the money emergencies that come your way.

Name the Need 

There is no “magic number” for an amount of money to be set aside in an emergency fund.  That number is unique to each situation and it depends on several factors - monthly income, number of dependents, amount of monthly bills, etc.   Another aspect of determining how much to save is personal comfort level.  How much “extra cash” would make you comfortable?  Generally, 3-6 months of living expenses is considered a good rule of thumb.  For people with lower incomes, a smaller amount ($500 - $1000) is considered a good starting point.  That provides protection for many emergencies while also allowing some flexibility for paying off debt and/or meeting other financial goals.  Whatever “the number” is,  label it as the savings goal for your emergency fund. 

When creating an emergency fund,

  • Separate this money from money used for bills and day to day expenses.
  • Save something, no matter what.  Saving a small amount is better than saving nothing.
  • It’s more important for this money to be accessible than it is for it to earn interest.

Create A Cushion

A big source of money stress is living “paycheck to paycheck”.   Life is good for a few days after payday but, it gets tough during the days leading to the next payday!  That cycle can cause a number of problems, not the least of which can be overdrawn accounts, late payments, strained relationships and sleepless nights!  To ease this stress, build a cushion into your main checking account.  Again, the exact amount of the cushion will depend on individual circumstances.  This cushion will pad the balance enough so that the last days before payday are more comfortable.  Certainly, a cushion in the checking account is a good thing.  Be careful that it doesn’t become a temptation to overspend the budget.

When operating with a cushion,

  • Code the balance in your checkbook register so that the extra doesn’t show up as being available to spend.
  • Make sure the written budget does NOT allocate the extra cash to a spending category.
  • Keep track of when the cushion is used so that future budgets can be adjusted.

Establish Emergency Procedure

“A real emergency is something that threatens your survival, not just your desire to be comfortable.”                                  - David Bach, The Automatic Millionaire

Once an emergency fund is in place, it can be very tempting to use that money for situations that are not true emergencies.  In fairness, it can also be difficult to know when an actual emergency presents itself.  Again, there are not hard and fast rules about what constitutes a money emergency so this is another area where specific circumstances and situations have to be evaluated.  What is a money emergency for one family may be anything but for another family.  The amount of money set aside in your emergency fund will help determine what it can be used for.  It is also important for you to outline a process for identifying a money emergency that will require you to spend money from your emergency fund.

When spending money from the emergency fund,

  • Be honest about what constitutes a money emergency. 

  • Make sure all decision makers agree that the current situation IS an emergency.

  • Only spend the amount necessary to get through the temporary situation.

Replenish Reserve

It would be great if money emergencies didn’t happen again and again and again.  But, that wouldn’t be realistic.  Usually, just about the time the water heater gets replaced, the dishwasher dies.  About the time the new dishwasher is installed, the brakes on the car go out.  Consequently, maintaining the emergency fund becomes as important as establishing/funding it to start with.  Make sure that money used from the emergency fund is returned to that fund as soon as the emergency has passed.   

To make replenishing the reserve easier,

  • put something from every paycheck into the emergency fund.
  • reduce or eliminate all extra expenses until the emergency fund is fully funded.
  • create an automatic deposit.

The great thing about an emergency fund is that you can start one today.  Any amount, no matter how small, is enough to set aside.  Whatever amount is there at any given time can ease financial pressure when you need it to.  With any luck at all, your money emergencies will be few and far between and this money set aside will help you make it through all of them.

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