What is an Emergency Fund
An emergency fund is a pool of money that has no allocated purpose other than to be available to you quickly in case of an emergency (health issue, car accident). It isn’t there for frivolous wants, but solely for the unforeseen expenses that will have a drastic effect on your finances.
People often ask how big of an emergency fund they should have. Most people recommend that you have enough money available in your fund to cover anywhere from 1-6 months of expenses (including your mortgage or rent). This is to ensure you can financially survive a traumatic life experience such as a job loss or a stack of unexpected medical bills.
Who Needs and Doesn’t Need an Emergency Fund
Having an emergency fund is never a bad thing, but I don’t think it is as high of a priority for certain individuals as other bloggers and personal finance experts believe. If you have a young family and a house, yes, you absolutely should have an emergency fund. If you are in your early to mid 20s (like myself and several of my readers), are renting and don’t have a family to support, you simply don’t NEED an emergency fund.
What Should I Do with my Money that I Don’t put in an Emergency Fund?
First things first, pay off your debt. If you are in debt, get serious about it and throw every penny you have at getting out of that hole. It should be noted that if you have been working to get out of debt lately and didn’t have an emergency fund set up, did you need one in all of that time?
Second, invest in a Roth IRA. The reasons why this is step number two is explained below. A Roth IRA is an asset unlike any other, and if an emergency doesn’t happen, think of what that money can turn into over time (please see my post Turning $5,000 into $110,000 (Tax Free) – All it takes is time. It’s safe to say whenever you have extra money, a Roth is probably the best place to put it.
Third, create sub savings accounts. Save money for your short to medium term goals with the money that you have left over.
Fourth, create a buffer in your checking account of a few hundred dollars (maybe $1000) to make sure you don’t overdraft your account when a bill is higher one month.
What Happens if an Emergency Occurs
Well, you tried to play the odds and hope that no emergencies would take place. Unfortunately disaster hit and now you need cash, and quickly. Don’t sweat it, just because you don’t have an emergency fund doesn’t mean you are screwed. You have several options in front of you.
- Option 1: I know no independent 20something wants to hear this, but ask your parents for money. This is an emergency and families are there to support one another. Swallow your pride a bit and ask. It may make things easier in the short and long term.
- Option 2: Take the cash from your short to midterm savings goals. I guess your trip to Paris isn’t as important anymore in light of the recent emergency or you may have to hold off buying a new car in two years (may have to push your goal back by a year or two, but hey, life happens.)
- Option 3: Take your contributions out of your Roth IRA. This would royally suck to do, but it is a legitimate option. You can take your Roth contributions out at any time without penalty. The caveat is that you can’t put them back in as if your Roth gave you a quick loan. If you have been putting $416.66 a month into your Roth to hit the $5,000 contribution limit, it’s possible that you have enough in there to last you a few months should something disastrous happen. (Please note: you can take earned money out of your Roth without penalty if you are paying significant unreimbursed medical expenses or are paying medical insurance premiums after losing your job.)
- Option 4: Charge it. Yes, it would suck to go back into debt, but if you were that focused about getting out of debt in the first place, you can surely do it again. Think of all you learned getting out of debt the first time, and think of how much easier it may be to get out of it a second time if it was a necessity.
How to Prevent an Emergency from Happening
If you want to avoid using your already established emergency fund, or if you are like me and don’t have a designated fund for emergencies, you should focus on preventing them from occurring. Here are a few tips to help prevent an emergency.
1)Get regular medical and dental checkups (this is the best preventative maintenance you can have and will make sure your body is in tip top shape)
2)Stay active. Eating and being healthy is easier said than done, but if we could all focus on this a bit more we are less likely to have expensive problems down the road.
3)Keep up with the maintenance on your vehicle. It’s amazing how many people equate their livelihood to their car. If your car gets regular checkups like your body does, it will last a lot longer.
4)Pick up a part-time job. Diversifying your income is the best way to hedge against job loss. Even a few hundred dollars a month is going to help you if you get laid off. This extra income can help boost your savings or Roth contribution; helping you in case an emergency does pop up.
I definitely don’t expect everyone to agree with me about the necessity of an emergency fund, but please remember I am only advocating this strategy as an alternative to younger adults who could be boosting their savings in the years when an emergency is least likely to happen. I personally don’t have an emergency fund, but I do have targeted savings goals and a Roth that I can tap into if necessary.
Please leave a comment and let me know your thoughts about this break from the personal finance norm of having an emergency fund.