Let’s examine the basis for all my financial planning: Your Financial Planning Tower, to see why. One of the key tenants supporting this structure is the Emergency Fund on the bottom. I’ve always said you need a strong base to build your finances and have always included this as a goal in a financial plan.
The purpose of an emergency fund is for you to have ready cash in case of, well, an emergency. Some synonyms for emergency are: crisis, catastrophe, dire straits, and point of no return. These definitions all imply truly life changing disaster.
We all know someone who has been through one of these experiences. Remember the 2008 economic downturn? How many people lost their jobs? Too many. Hurricanes, flooding and wild fires seem to be a news item almost every night. Unexpected health issues definitely take their toll on an entire family.
So let’s replace that Emergency Fund with one of these titles:
- The ‘Oh My God I Lost My Job Fund’
- The ‘Oh Crap My House Burned Down Fund’
- The ‘I Can’t Believe I Have Cancer Crisis Fund’
These are events that truly qualify as an emergency, and that is what an emergency fund should be used for. The general industry is to have anywhere from 4 to 6 months worth of expenses on hand. Having access to a large dollar amount can help you support your standard of living, keep your home, or maintain extra expenses for the next several months while you regroup and determine how to best move forward after a crisis.
What’s NOT An Emergency?
Many people use their emergency fund for expenses that are not truly emergencies. So where does the money go? Maybe new tires or car transmission. Sometimes a water heater or air conditioner. Maybe medical deductibles or co-pays.
Are these emergencies? They may seem like it at the time, but truly, these are expenses that are part of the upkeep on a home, car, or yourself.
Are they aggravating and annoying? Yes! Are they sometimes massive expenses? Yes! Are they emergencies? No.
You should plan for all of these events by saving money separately from your emergency fund. “Households that plan ahead for large, irregular expenses are 10 times as likely to be in the financially healthy segments than those that do not plan ahead,” according to the Center for Financial Services Innovation.
Maintenance funds are like the Savings for Short Term Expenses category in our Tower. This can be a separate savings account that you can raid for damages and repairs. You are likely to be in and out of this account more often than your ‘Crisis Fund’, so be sure you can access it easily.
So, get rid of the Emergency Fund nomenclature and rename it something dire that resonates with you. Then, be sure to set up a maintenance account for other unexpected expenses. Doing these two things will help you dramatically improve your financial health and build your Financial Tower.
Pamela J. Horack, CFP® of Pathfinder Planning LLC provides personal financial planning advice and asset management for a simple fee to young adults and working families in North and South Carolina through group classes, one-on-one planning, and ongoing advice.