What truly constitutes an emergency? Many of us tend to justify taking money out of our rainy day fund by calling something an emergency when, really, it’s not a true emergency. As you work on building your emergency fund, take a step back and consider how you will use the money you accumulate.
Dr. Stephen Lesavich, the co-author of The Plastic Effect: How Urban Legends Influence the Use and Misuse of Credit Cards, suggests to create spending rules so your emergency fund doesn’t become a sort-of general fund that you raid whenever you feel like it. Here’s how to put spending rules on your emergency fund, that you’ll actually stick to.
Define What a True Emergency Is
Your first step is to figure out what counts as a true emergency. The fact that your TV broke and you’d like to get a new big flatscreen doesn’t qualify as one.
“You should identify what a typical emergency for your household at your income level is,” says Lesavich. This means you should consider what it might cost to fix a car, buy a new washer, or pay dental bill. “For many people, just putting $100 a month is enough to get a good start on these types of emergencies.”
It’s better if you can set aside a little more, of course, but Lesavich says,
it’s better to start small than to avoid starting at all.
A true emergency is anything that comes up that impacts your life in a very real way. If you need to be able to get to work, a car repair is an emergency. If your fridge breaks down, you need to buy a new one, since your food will spoil without it. Get back to the basics of needs vs. wants, and understand that a true emergency is something that is related in some way to true needs and survival.
Make the Funds Harder to Access
Lesavich says that it’s been more than five years since he’s had a true financial emergency. As a result, he has quite a bit of money stored up. If you don’t like the idea of a huge amount of money sitting in a low-rate savings account, you can invest a portion of it.
“If you have an emergency fund, and no emergencies occur, you can remove some of the money and transfer it elsewhere, such as to a CD, or to some other investment like stocks or bonds,” says Lesavich. “That way, the money is working for you, helping build your net worth, but you can still access the money if you have a major emergency.”
Lesavich suggests that 25% of the fund is a good amount to move over, but if you have a large enough account, and are confident you can handle most small emergencies after moving 50% or 75% of the money elsewhere, that might not be a bad idea.
The idea is to keep your short-term savings really accessible, so you can access them when you need quick money to cover a tow bill, or buy a new dryer. However, you still want to have money available to you (though it may take time to access) in case you have a larger emergency.
What rules do you have in place for your emergency fund? How do you keep yourself from spending it on wants, instead of saving it for needs?
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