What’s An Emergency?
If you’ve spent any time thinking or reading about the subject of personal finance, you will have come across the concept of an ’emergency fund’ before. Put simply, an emergency fund is a reserve of money held in a highly liquid (easy to convert into cash) and secure (low risk) manner. The idea is that rather than relying on credit or investments, this money is to be used in case of an emergency that requires an unexpected and unforseeable financial outlay. Unexpected car repairs, health concerns and losing your job are all examples of things that are often cited as reasons you might use your emergency fund.
Different financial folks will advise you keep different amounts in your fund. In the light of recent economic turmoil, many have advised a more conservative approach suggesting you keep as much as 12 months worth of expenses in an emergency fund. Personally, I keep 3 months worth.
[As an aside, the reason I only keep 3 months worth is because I have no consumer debt, no children, my husband is employed and the opportunity cost of keeping more than that is just too great.]
Recently however, I’ve had cause to think this over in more detail. Not to necessarily revise the amount that I keep per-se, but to really consider what my emergency fund is for. Traditionally, I always viewed this as money I’d use if I lost / resigned from my job. If this is the case however, what would I do if I had to leave my job for health reasons? Or if I just wanted to resign to say – pursue other opportunities – and I was was living on this “emergency” stash, what would I do in the case of an actual emergency, like those highlighted above?
In this article about the $0 Emergency Fund, Liz Pulliam Weston discusses this theme of having to deal with more than one crisis at a time, as well as my aforementioned concern about the opportunity cost of a substantial emergency fund. Whilst I don’t agree with her advice later in the article about the use of credit to cover emergencies, I like her thinking around not requiring the source of your emergency fund to be cash – but rather focusing on financial flexibility.
Late last year, Five Cent Nickel also discussed when to use an emergency fund. Here, he makes a good point that if your emergency fund is for multiple purposes – that is, for if you lose your job as well as for unforseeable car expenses or house repairs or health expenses – then you need to pay your fund back what you “owe” it.
Essentially, it seems the clarity of an emergency fund is extremely important - both in terms of the intent of the emergency fund, as well as how it’s broken up. For example, I may do better to rename my current emergency fund as my “Stick It To The Man” or “Follow My Dreams” fund, and then have another, actual, emergency fund of a few thousand dollars to cover more traditional “emergencies”.
Increasing passive income sources too, seems an attractive option. That is - income that is received if not in traditional full-time employment. Investments such as shares (which pay dividends) art (which is rented) and property (also rented) are options for providing an income stream that is not tied to a primary source of income.
Ultimately though, what an emergency fund means to any given person will depend very much upon how financially sophisticated they are. If you’re up to your eyeballs in debt and are just beginning to work your way out, it’s pretty reasonable to assume that your emergency fund is going to be small and many things are going to throw you off your plan. As long as you’re honest with yourself about what constitutes an emergency (your TV breaking, or a birthday you forgot about is not), and you’re comfortable that life can throw you a few knocks without you needing to declare bankruptcy, then that’s what matters.
Emergency funds are not, it seems, a one-size-fits-all concept.
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