Picture this: you’re driving to work, frustrated at the lack of quality choices in music. As you reach over to change the station, the car in front of you suddenly hits their brakes. You utter some choice words and swerve to narrowly miss the car in front of you…but hit the street lamp. Thankfully it’s just a fender bender, but it’s still an unwelcome way to start off the day. When you finally get into work, you’re met with news that the company is going to be announcing layoffs at the end of the week and that your division is potentially on the chopping block. You call your spouse to let them know the bad news, when they inform you that a pipe burst in the house and flooded the entire basement – ruining everything stored there, and most likely requiring an extensive (read: expensive) repair. Sounds like a pretty awful day. Now here’s the quiz: which of those situations are emergencies?
As I’ve been reading more about personal finance, I’ve found that different authors define “emergency” differently. And all of these definitions may be valid, depending on the situation. But I realized I needed to make sure I fully understood what MY definition of emergency was in order to make sure I was saving enough in my “rainy day fund” and using it for the purpose I designated, rather than taking some guru’s arbitrary number and assuming it would be sufficient for my needs.
While this is not a comprehensive list of definitions by any stretch, these are just a few of the different definitions of emergency I’ve gathered.
- “Entropy happens”: This is the first part of Dave Ramsey’s “baby steps” to financial freedom. This would include things like car accidents, unexpected trips to the ER, stuff in the house breaking down, etc. Ramsey recommends keeping at least $1,000 around for these sorts of “emergencies.” Other financial writers argue that these types of expenses should actually be expected and ought to be budgeted into monthly expenses, since statistically those things are probably going to happen at some point in life. Some argue that the number should be higher.
- “Unemployment money”: Notably, Suze Orman recommends 8 months’ worth of monthly expenses to cover this type of emergency; Dave Ramsey advocates a 3- to 6-month fund once you are out of debt, and many others recommend similar amounts of funds. Job security is not very high right now. It doesn’t matter what sector of the economy you work in, it seems like I’m learning about yet another person who was laid off because of budget cuts, or looking for new employment because their current job is squeezing them too tightly. Or, on a more worrisome note, perhaps you’ve developed a permanent disability that prevents you from being able to work in your previous capacity. The rationale behind this definition of emergency is to have a buffer between jobs. Orman has argued that 8 months of current monthly expenses are now the minimum requirement because it is taking far longer for people to find jobs – and while we would like to think we can become more minimalistic in our expenses during those periods of unemployment, we are more likely to continue spending at the same rate – and could then fall into inescapable debt as a result.
- “Life ruining expenses”: This would include things such as short- and long-term disability and other potentially devastating medical expenses, sudden loss of a spouse/child or other close family member, suddenly adding a new financial dependent (such as a parent or grandparent or a niece/nephew or grandchild; not like a kid since you get 9 months to get things ready), getting divorced, getting sued, or suddenly losing everything like being in a tornado. Now, typically this is what insurance is designed to help protect. But many of us are probably underinsured for these sorts of events (or the insurance that we have doesn’t cover everything). Because this situation is much harder to predict, most financial advisers recommend getting appropriate insurance to help cover this cost, rather than trying to pour tons of resources into a fund that may never get touched or get so rapidly depleted that it’s not even worth keeping separate from the rest of your resources.
- “Go to **** money”: This is an important option for those people in bad work situations. Now, in the truest sense, the “go to ****” fund is separate from other types of “emergencies” because this is still a voluntary situation – after all, no one is forcing you to leave your job if you want to quit. But I add this category into the “emergency” discussion because this savings goal is a “just in case” goal as well.
- “Zombie apocalypse” money: Some people are very into the stockpiling for the end of the world. However, most of that storage is of survival gear and supplies, rather than finances. I can understand that – I doubt zombies accept major credit cards.
So what’s our approach to emergency savings? Well, our experience is tempered by our sabbatical last year, as we moved states and settled into our new jobs. We went on a nearly month-long road trip (which was extremely fun and completely worth it), bought a new car and house, and moved during a 3-month span where neither of us were working or drawing any sort of income. At the end of that season (my start date was September 2, 2014), our cash balance was negative (thankfully I got paid before our credit card balances were due), with over $100,000 in student loan debt, over $25,000 in car loans, a 6-figure mortgage, and only a little bit in investments and retirement that I had neglected in accounts from college. So as we’ve been working to rebuild that unemployment fund, our strategy actually encompasses three of the definitions to some extent:
- “Entropy happens” fund: We funded a small account of “flex” money that we can tap for larger unscheduled expenses that are still somewhat expected. If we do need to withdraw some money from this account, it’s not a big deal – it can always be replenished over time.
- “Unemployment money” fund: Although we both work in highly specialized fields that are in fairly high demand, we still want to be prepared in case one or both of us unexpectedly lose our jobs for any reason. This fund will tend towards the higher side for now while we work on paying off my student loans and the car loan (yes, I know we can put the student loans into forbearance or do some hardship options, but we want to be out of debt ASAP). Once we’re out of debt except for the mortgage, we’ll probably be able to scale back on this fund. Regardless, we hope never to have to touch this money.
- “Life ruining expenses” fund: I’m exploring different insurances that will help take the brunt of most of these types of expenses, since I don’t see any point in specifically allocating a ton of money to a fund that we hopefully won’t have to touch but maybe once in our lifetime (or not at all). I figure if things were really that disastrous, we’d burn through all of our money so quickly it wouldn’t matter what funds we had set aside.
- “Go to ****” fund: We are also setting aside a bit of money into this fund. Again, we hope never to touch this money, and we’re viewing this fund as more of a “in case we need/want to move” fund, rather than the traditional definition of this fund. While we’re enjoying our lives and jobs right now, seasons change and there’s always the possibility that we may have to move for family reasons or unexpected job reasons. The goal of this fund is to have enough money to cover the costs of selling our house and moving expenses if we need to relocate, as well as having some flexibility in case of having to cover medical expenses (or insurance coverage), etc.
- “Zombie apocalypse” fund: I figure I’ll probably get eaten pretty quickly, especially if I’m on call that day. At that point I doubt money will matter to anyone.
What do you think about emergency funds? How much do you think is enough, and is our current plan overkill? Leave a comment!
Books About Emergency Savings I’ve Read (full disclosure: I just signed up for Amazon’s affiliate program so purchases made through these links give me a small percentage of what Amazon receives – does not affect the actual price of the books though):
- Personal Finance For Dummies, by Eric Tyson: This is a pretty good intro to personal finance. I didn’t completely agree with his approach to investments or his perspectives on real estate, but it was definitely a gentle entrance into the world of personal finance.
- The Total Money Makeover, by Dave Ramsey: Say what you will about the guy, he provides a very practical and strong framework to start the journey towards financial freedom/independence. There are many points that I agree with him on (having a cash reserve, getting out of debt as quickly as possible, etc.), but there are also some other things I don’t quite agree with (I prefer the mathematical approach to paying off debt rather than the “Snowball” technique he advocates, I think his investment strategies aren’t completely realistic, and are probably too general to accurately apply to each person’s situation, the approach to student loan debt for graduate students, etc.). It’s still a good entry read, but after planning out the steps out of debt, I found myself thinking, “what next?” TMM doesn’t really help with those next steps and in my opinion was never written to be all-inclusive for that reason.
- The White Coat Investor: A Doctor’s Guide To Personal Finance And Investing, by James M. Dahle, M.D.: I will review this book in greater detail (and these other books as well) in another post. While this book primarily focuses more on the other bigger picture issues, he does address the idea of retaining a cash reserve. Physician’s situations look very different in some respects from people in other professions, but I think they can still be pretty applicable.
- The Money Book for the Young, Fabulous & Broke, and The Money Class: How to Stand in Your Truth and Create the Future You Deserve by Suze Orman: There were a lot of books by Suze Orman at the public library. Orman’s principles, which are every bit as dogmatic as Ramsey’s, touch on similar issues: having adequate cash reserves, getting out of debt, aggressively saving for retirement as quickly as possible, and investing the rest. She probably advocates for the largest amount of emergency cash-reserve savings out of all the financial “gurus” I’ve read – 8-12 months of currently monthly expenses (which can be in upwards of $80,000 for some people!). I may do a few posts analyzing my understanding of all of these different approaches.