Why You Need an Emergency Fund Already

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Why you need an emergency fund

It was so innocent. I mean, we just used the toilet as we were leaving the house. We had no idea it would leak in the bathroom, go through the living-room ceiling and drip on our wooden floor.

The leak had been slowly building up for the last 10 days.

Of course we couldn’t detect it earlier since we had not moved in yet. But we were already cutting the ceiling open, drying the wooden structure, applying mold treatment, fixing it and repainting it.

Final cost: 650$. Not cheap, but there’s nothing we could do about it, so we paid and moved on (or actually in).

And this wasn’t a bigger financial deal than that. Why? Because we have an ‘oh-sh*t’ fund that we have built over the years, for all those emergency expenses. We just had to take some cash out of it.

State of Emergency

According to the Fed’s latest Economic Well-being of US Households, only 53% of households can cover an expense of 400$ with cash. Put another way, almost half the population has an emergency fund of less than 400$. There is even 27% of the households making 100,000$ or more that can’t pay cash for a 400$ emergency.

Capacity to pay 400$ emergency in cash

This is scary and frankly ridiculous.

The Personal Finance community talks about building emergency funds to cover 3 or 6 months of expenses and half of the population can’t pay a 400$ emergency with cash.

So let’s say a kid gets sick, something breaks in the house or the car needs a repair and half the population finds itself under financial stress. This builds up credit card debt and put downward pressure on the ability to save and build an emergency fund.

The good news? The main financial challenge for households to cover unexpected expenses is health care, more precisely dental care. If that’s your case, see how I negotiated a discount on my dental bills.

Only 13% of households making over 100k$ save more than 20% of their income

The next reason households seem to be short on ‘oh-sh*t’ cash is their low savings rate. I can understand that only 8% of household making under 40,000$ save over 20% of their income (including their 401k contributions).

But I find it very disappointing that those making 100,000$ or more only represent 13%. Lifestyle inflation is very real.

Considering that the top 2 reasons, according to the survey, that household save money are ‘Retirement’ and ‘Unexpected expenses’ but that almost half can’t cover a 400$ expense, I suspect that there isn’t much cash outside of their 401k.

So what can you do about it? Actually quite a lot.

Waste Reduction

I realize that I earn and spend more than average, but there are some things that I can’t afford to put my money into. I recently went through the exercise of building up savings to use as a down-payment for a house and the same method can be used to build up a cash pile:

  • Cable TV – out! I can’t afford to pay 200$/month for cable TV. The value is way too low for the price and even if it sounds cliche, this is definitely the first thing to go. Now I pay 30$ for internet and putting 170$ / month towards an emergency fund holds a lot more value to me than having cable TV. 1 year of savings = 2,040$.
  • Eating out – done! It was hard at the beginning since we love to go out for lunch. But the truth is, in addition to saving 600$ / month, we are also much healthier. This also forced us to buy fresh groceries in bulk from a co-op nearby which didn’t increase our groceries bill. 1 year of savings = 7,200$.
  • Electricity – switched! If you have the chance to live in a state where electricity is deregulated, you can switch electricity and save every month, it’s passive saving! In 2015 we payed 0.09$/kWh. In 2016, we’ll pay 0.07$/kWh. 1 year of savings = 250$.
  • Home repairs – negotiated! Well technically, that didn’t help me with the downpayment, but since we had repairs before even moving in, it helped with the acquisition costs. I asked all 3 contractors if they could do a discount. Not pushy, just asking. 1 said no, 2 said yes. Savings = 150$.
  • Healthcare bills – negotiated! I negotiated my dental bills last year and saved 1,150$. This wasn’t a quick win, but one that turned out very well. Remember that you don’t get what you deserve, you get what you negotiate.

If you are keeping track of the savings, that’s 10,790$ saved over 1 year. I’m not saying that everyone can save that much, but everyone has some kind of expenses that can be cut.

Most households should be able to build a 1000$ emergency fund in 6 months or less.

Invest in Preparedness

But let’s be honest, 1000$ in emergency fund is not enough. Looking at the reasons that people experience financial hardship, health is a big concern (37%), tied with the combined loss of job of one member in the couple (another 37%). See what the Fed found below:

Financial hardship reasons

In neither case is 1,000$ realistically going to be sufficient. Even if you’re the most frugal person and your family spends less than 25,000$ a year, one thousand dollars only represents 2 weeks of expenses.

You’d Better be safe than sorry

Whether you need 1 month or 6 months of living expenses in your emergency fund is debatable. But 5,000$ would probably be a good start for anyone.

I personally have about 6 months of expenses in my emergency fund, which may be a little more than I need, but with the oil prices under 30$ now, I prefer having more than less.

How is your emergency fund doing?

My emergency fund can cover my expenses for:

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If you do not have cash sitting in a savings account that you can dip into for emergencies, cut the waste and start building it up today. Being financially independent starts by mitigating risks.

As the saying goes, “Better safe than sorry”. I think that pretty much sums up what an emergency fund is about!

-Nick

Further reading: Report on the Economic Well-Being of U.S. Households in 2014

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2 COMMENTS

    • I feel exactly the same. At the beginning, it was very important for me to have security and my fund grew quite large. As time goes and I ‘optimize’ my finances, I’m feeling like reducing it a little and invest the rest.

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