At first, the question seems to raise a simple black-and-white scenario: You’ve saved for a rainy day, an emergency arises, and you dip into your savings to cover it.
Real-life, however, comes in as many shades of gray as individual financial circumstances. Factors that influence your rainy-day spending can include income vs. expenses, how much you have saved, and your fiscal discipline, to name just a few.
The ideal approach to potential emergency spending is to incorporate it into a financial strategy that addresses your situation and helps prepare you for both planned and unplanned expenditures.
Before you tap into that rainy-day fund, ask yourself…
What Constitutes an Emergency?
Everyone has his or her definition. Rather than deciding how to spend based on the emotions of the moment, consider your strategy before you’re confronted with an emergency. Define the circumstances under which it’s worth depleting your savings:
1. Is this urgent?
Do you need to address the situation immediately? If your car transmission blows, for example, and public transportation is not an option, the answer is yes. You must repair your car to get to work and around town. Before you tap into savings, though, ask the mechanic if you can set up a payment plan and fit the repair cost into your regular budget.
On the other hand, if you drive an aging car and want to upgrade before expensive repairs start, that’s a planned purchase. You can save up for a down payment and shop for a model and a financing plan appropriate to your budget.
2. Is this unavoidable?
Emergency medical treatment for you or your pet is an unavoidable expense. A pop-up getaway to Las Vegas is not. In between lie those many shades of gray.
“Unavoidable” means the money must be spent to avoid an adverse outcome. But must you draw down your savings? If you break your leg, you need treatment, but can you pay off what your insurance doesn’t cover in monthly increments?
Be careful not to mistake a compelling want for an unavoidable need. Replacing that old-but-still-serviceable couch in time to impress your friends and family at your housewarming party counts as discretionary spending.
3. Did you see this coming?
A necessary but predictable expense—health, car, and home insurance; mortgage; tune-ups and oil changes; groceries; etc.—is not an emergency and should be covered by your budget. Don’t overlook bills such as quarterly insurance premiums and annual membership dues that arrive less frequently than once a month. You can divide annual totals by 12 and incorporate that amount into your monthly budget.
Job loss creates an exception to the rule against paying regular bills with emergency savings. After all, an unemployment cushion is one of the main reasons to have an emergency fund. If you’re between jobs, shrink your discretionary spending as much as possible so your savings will see you through. When you find a new position, adjust your budget to replenish your emergency fund.
No Savings…Now What?!
A detailed look at your non-discretionary expenses can help you determine how much emergency cash to hold. Most rules of thumb will guide you toward 3-9 months of those expenses, and a financial advisor can help finetune that estimate and determine where to stash your savings so they can be accessed quickly while still earning the highest interest possible.
If emergency savings are not part of your financial life, you’re not alone, —28% of Americans have no emergency fund, according to a recent survey. One in four people with rainy-day savings says theirs does not cover three months’ worth of living expenses.
We hear many reasons for inadequate emergency savings—steep debt, college tuition, higher priority savings such as retirement, or home buying. The fact is, an emergency can derail your finances no matter where else you’re allocating your income right now. Incorporating an emergency fund into your other financial priorities can increase the chances you’ll reach your other goals sooner.
Our advisors at FJY Financial can help you assess your current spending, saving, and investing activity and help ensure your assets cover the priorities you can plan on and the emergencies you can’t.