What is an Emergency Fund?

An emergency fund is at the core of a healthy personal finance portfolio.  Certainly, having a buffer for emergencies is a major help to prevent the need to tap into very high interest rate pay-day loans, credit cards, and other emergency borrowing.  However, I’ve noticed that the term emergency fund has been a victim of definition creep with a lot of people using it the fund to pay for irregular or seasonal costs as well as things that should have been planned for.  While it is still better to have this fund to tap into, this behavior puts a lot of people at risk in case a real emergency hits (especially if the emergency fund is not replenished immediately). Here are some examples:

–A car repair bill when your car is getting older– I would separate these into two categories.  Having the mechanic find you need to replace your carburetor after many years of being fine is an irregular expense. If your car is getting on in years, you should be setting aside funds for higher maintenance bills, tire changes, and replacements.  Having someone accidentally tail end you, in contrast, is an unplanned expense and better qualifies as an emergency fund candidate.

–Irregular home maintenance repairs — similar to car maintenance, air conditioners, washing machines, roofs and other things will need repair from time to time. There should be a reasonable maintenance amount set aside each month as these are irregular, but should not be unexpected.  A lightening strike that hit your fireplace however, is an emergency.  Hopefully, your homeowners insurance will cover the damages, but the deductible or excess charges qualify for an emergency.

–Irregular medical or health expenses — such as braces, one off tests like a colonoscopy and other things. These occur infrequently (like once) but should also not be unexpected.  Obviously, an unexpected medical issue is an emergency.

–Having bonuses cut or furloughs instituted at your place of work — one of my friends Will, tapped into his emergency fund because bonuses at his workplace were down sharply compared to the previous year.  Irregular income and reductions in pay should result in a redrafting and re-examination of your monthly budget. Tapping the emergency fund to return to past spending levels is a dangerous way to permanently deplete it. Try to preserve the emergency fund for things like an unplanned division closure or unforeseen layoff.

shared at this week’s Carnival of Personal Finance