What is an emergency fund (and why you must have one)?

My mom and dad used to force me to save some of my money that I earned when I was a kid. Of course, I hated it. I wanted to spend it all on candy and toys. They would say I needed to save it for a rainy day – whatever that meant (nothing to me as a teenager).

You might even say this to your kids. But how is *your * rainy day fund?

Life happens

There are some things in life you can’t plan for:

  • getting laid off from work
  • your car breaking down
  • an unplanned pregnancy
  • being unable to work due to health issues
  • the A/C breaking down in the middle of summer
  • Fido or Fluffy getting sick (Jake and Riker in my case)

In the 40+ years, most adults will work, an unexpected event is going to happen. It’s not a matter of if, it’s a matter of when. Will you be prepared?

Are Visa and Mastercard insurance policies?

For most people, the rainy day fund is Visa and MasterCard.

With the average credit card balance $15,611 does it make sense to create more debt during an emergency?

Remember – you can’t get out of debt by creating more debt.

Prior to paying off your debt, you need a buffer, a cushion, a safety boat you can hop into when the typhoon is coming. And the typhoon will come. It’s brewing out on the horizon. Or maybe it’s just over the horizon where you can’t see it. All you see is the pretty orange and red sunset. But it’s there, and it will make an appearance in your finances. The only question is are you going to get soaked or do you have a big enough umbrella to keep you dry.

How much should I have in an emergency fund?

$2,500
The amount you should have in cash for a rainy day fund. This fund is for emergencies only.

This is your umbrella to keep you dry during the typhoon. It’s there to help get you out of debt by preventing you from creating more debt.

Why do you think they call it a rainy day fund? Because it is going to rain, you just don’t know when.

Why $2,500? $2,500 is going to cover most of your major expenses that could crop up – failed A/C system, transmission failure, out-of-pocket medical deductibles.

Only break glass in case of emergency

I mentioned earlier some examples of what an emergency is.

Let’s be clear what an emergency is not:

  • Prom dresses
  • Braces
  • Cracked iPhone screen
  • iPhone upgrade
  • Christmas presents
  • Dinner out when your friends are in town that you haven’t seen in 2 years

Here’s a test you can use to determine what is an emergency is.

What happens if there is an emergency?

You pay for it with cash out of your rainy day fund. By doing so you don’t create any more debt for your family, and you continue your path to getting out of debt once and for all.

But do you know what the nice thing about your rainy day fund is?

A rainy day fund acts like emergency repellant.

It’s when you don’t have an emergency fund that things tend to break and go wrong. But when you are prepared, when you have the cash insurance in case something does go wrong, things tend to go wrong much less frequently.

Now there is no statistical evidence of this, but it’s the general feeling of people with emergency funds compared to when they didn’t have them.

If you’re car breaks down tomorrow and you can pay for the repairs in cash, wouldn’t that be a good feeling? That beats paying 18% interest on the repairs for the next three years and having it cost two or three times as much.

I’ve had an emergency fund for 15 years, and I’ve had to use it a few times. The air conditioning broke in our townhouse just after I was married ($3,000), and the air conditioning broke in my current home just last summer ($1,800).

Getting your umbrella ready again

If you do have an emergency and deplete your rainy day fund by any amount your first order of business is to build it back up to $2,500. Stop paying EXTRA on your debts for the moment. You do continue to pay the MINIMUMS.

Take the extra money you were paying towards your debts and build back up your $2,500 in cash for the next storm.

It’s coming – be ready.

Meet Joan

Joan has sold a bunch of her goodies and stuff that she realized she no longer ‘needs’ to create a $2,500 rainy day fund. Three months into destroying her debt Joan’s car engine starts sputtering, and the mechanic says it’s going to cost $400 to repair.

Joan pays cash for the repair out of her rainy day fund. Joan is very happy to do this because she isn’t creating more debt for herself by paying in cash.

For the first time in her life, she is getting ahead instead of getting further behind. She then starts making only the minimum monthly payments on her debts instead of paying extra. She takes the extra she was applying towards her debts and saves up $400 to get her rainy day fund back to $2,500.

Joan is now ready for the next storm. When Joan’s rainy day fund is fully replenished to $2,500, she immediately goes back to paying extra towards her smallest debt.

Simple, right?

What if I’m in debt?

If you’re in debt, prior to getting out of debt it’s more important to create an emergency fund.

While you may question the logic, having an emergency fund in place is going to keep you from taking on more debt when an emergency hits. There’s something about having $2,500 cash lying around for emergencies that tend to keep emergencies from happening.

Where am I going to get $2,500?

For many people having $2,500 in cash is more than they have ever saved in their lives. But you can do this!

And once you do, you will feel empowered.

To quickly create your $2,500 emergency fund there are two options:

  1. Make more money (overtime, work a side job)
  2. Sell stuff

You might be thinking you can’t do it, but I’m betting you can.

I don’t think I need an emergency fund

You can’t afford not to have an emergency fund. If you are thinking you can just keep one credit card around to use ‘just in case’, BOOM! You’re simple plan to getting out of debt is going to get torpedoed.

I’m going to keep repeating this – you can’t get out of debt by creating more debt.

Using a credit card for ‘just in case’ emergencies is going to create more debt for you.

A $5,000 credit card balance plus a $750 car repair is $5,750 of debt. That math holds true no matter what you do. A $5,000 credit card balance plus a $750 ‘oh this is just a one-time emergency charge’ is never going to equal $5,000. It’s always going to be $5,750 of debt – $750 more than when you started.

You can’t make your debts smaller by making them larger, right?

Having an emergency fund is one of the simplest and most important things you can do to improve your finances and keep from further going into more debt. There is a storm coming, right? Be prepared.

Question: Do you have an emergency fund? Please leave a comment on Facebook or Twitter.