Emergency fund

Why the emergency fund gets a bad rap

The emergency fund often gets a bad rap. After all, the word “emergency” brings to mind images of car crashes, natural disasters and terrible accidents – and who wants to think about that?

It’s also hard to imagine ourselves in emergency situations that are hypothetical and unpredictable, especially when the needs and wants of our actual life are more real and immediate.

However, emergency expenses come in many forms and there are less traumatic examples that would be equally good at messing up your financial situation.

So if you’re not feeling the emergency fund, try thinking about it as a “life happens” fund instead.

Define “emergency”

If an expense is unexpected and it has the ability to derail your regular cash flow, then it’s an emergency expense. By that definition, a delayed insurance reimbursement is as much of an emergency expense as a meteorite landing on your car. The important part is being prepared for those expenses, no matter how mundane or how extreme they turn out to be.

Let’s look at what types of expense should – and shouldn’t – be dealt with by an emergency fund.

Expense type #1: Known unknowns

“Known unknowns” are situations that we can partially anticipate and is the type of expense that should not be dealt with by an emergency fund. These situations are on our radar (known), even if we don’t know exactly when they will happen (unknown). For example, if you own a vehicle, you know that at some point it will need repairs, just like you know that your home will eventually need a new furnace or that your pet will eventually need a visit to the vet.

A good budgeting exercise is to make a list of all the known unknown expenses you can think of. Then compare the list to your budget and see if there are any categories you’re not currently saving for. Odds are that there are probably a few areas your current budget doesn’t cover, so you’ll want to adjust it to include these additional categories.

Expense type #2: Unknown unknowns

“Unknown unknowns”, which are the types of expenses that emergency funds are truly designed for, are situations that take us completely by surprise. We don’t know when they will happen, how much they’ll cost or even what they will be until they’ve happened. For example, a family member could suddenly fall ill and you need time away from work in order to care for them. Hopefully, you’ll never experience an unknown unknown, but if you do, the knowledge that you have an emergency fund to cover additional expenses will undoubtedly help to ease a stressful situation.

Expense type #3: Underestimated known unknowns

Although your emergency fund is not intended to cover known unknowns, if one of those situations has spiralled into a bigger-than-expected expense, that is something your emergency fund would be able to cover. For example, although you have a budget for regular vet visits, you discover that your beloved pet needs surgery, which will cost $2,000. Or you might have savings to cover your car insurance deductible, but it takes three months longer than expected to receive reimbursement from the insurance company. In these situations, it makes sense to dip into your emergency fund to cover an underestimated known unknown.

How much?

Emergency funds vary widely from person to person. The regular recommendation is six months’ worth of expenses, but some prefer having nine months’ or a year’s worth tucked away. It’s a significant amount, as it should be – it’s what you would be living off if you didn’t have an income for an extended period of time.

Saving six months’ worth of expenses might sound downright impossible right now – and that’s a completely normal reaction. Instead of feeling overwhelmed and giving up on the idea, choose a smaller goal and then gradually increase it over time.

When you’re just starting out, aim for $500 in your fund. Once you’ve reached that goal, think about setting a new goal of $1,000. Once you get there, consider setting weekly or monthly contribution goals to stay on top of your savings.

Ultimately, your emergency fund is about your peace of mind. Design it to fit your specific needs.

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