Building an emergency fund is one of the most important steps in achieving financial security. An emergency fund is money set aside for unexpected financial emergencies, such as medical bills or loss of income.
Typically, these funds are held in high-yield savings accounts and help cover urgent expenses that arise outside of your normal spending budget. A good rule of thumb is to put away three to six months worth of living expenses. Having this fund will prevent you from having to pull cash out of retirement funds or go into credit card debt for any unexpected emergency.
When to use your emergency fund
Don’t be afraid to use your emergency fund if you need it. That's what it’s there for. However, it shouldn't be used for all expenses. The following expenses are when it's appropriate to spend from your emergency fund.
Job loss or pay cut
One of the most pressing financial problems is losing a job unexpectedly. If you find yourself in this situation, then you’ll likely have to take out money from your emergency fund to cover living expenses until you become employed again.
Similarly, if you take a significant pay cut, you’ll likely need to spend from your emergency fund to supplement your income. In this case, it’s also best to revise your budget to cut back on spending and save where possible. You should also talk to your loan issuers for hardship or forbearance plans.
By having an emergency fund in situations like this, you’ll be able to avoid racking up credit card debt. Once you become employed again, or get a pay increase, make sure to prioritize building back up the funds you had to use.
Other unplanned expenses that typically end up being very costly are medical bills. As out-of-pocket healthcare costs increase, getting injured or sick and needing medical attention can have you walking away with expensive bills to pay. Even if you have medical insurance, you may still find it hard to meet your deductibles or co-pay. Plus, you may have to miss work due to a lengthy hospital stay, missing out on expected income. Therefore, medical emergencies are an appropriate time to spend from your emergency fund.
Emergency home or auto repairs
Similar to medical emergencies, emergencies to your home and vehicle are often unexpected and unfortunately, expensive. You might get into a fender bender, requiring costly auto repairs, or maybe your refrigerator breaks and you have to get a brand new one. For these situations, it’s smarter to spend the money from your emergency fund instead of putting these bills on a credit card. This could raise your credit utilization and leave you stuck with expensive interest payments.
Again, just make sure these repairs are urgent and necessary, not just a good deal, before pulling from your emergency fund.
When to not spend from your emergency fund
When trying to determine whether or not it’s a good idea to spend from your emergency fund, the big take-away is to determine whether or not the purchase is necessary and immediate.
If it can wait, it might be better to save for it rather than paying for it with cash from your emergency fund. For example, your emergency fund should not be used on non-essential spending, like vacations or a new wardrobe. You also should budget accordingly each month so as not to have to use it for routine expenses, like paying taxes or purchasing holiday gifts.
Here’s a list of questions to ask yourself when determining whether or not to spend from your emergency fund:
- Is this absolutely necessary?
- Is this the only way I can pay for this?
- Is this urgent?
- How long will it take to rebuild my savings?
Building an emergency fund is an essential step in achieving financial security. By having one, you’ll be able to deal with any unexpected financial emergencies that arise, without having to take on lasting debt. Your emergency fund can help you cover urgent medical expenses, home and vehicle repairs, and loss of income. Setting a savings goal, budgeting and making routine contributions can help build up your emergency fund over time
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Erin pairs personal experience with research and is passionate about sharing personal finance advice with others. Previously, she was a freelancer focusing on the credit card side of finance, but has branched out since then to cover other aspects of personal finance. Erin is well-versed in traditional media with reporting, interviewing and research, as well as using graphic design and video and audio storytelling to share with her readers.