Building a solid emergency fund is essential for safeguarding against surprise life expenses. However, the 2013 Assets and Opportunity Scorecard revealed that 44 percent of Americans were “liquid asset poor” just recently, meaning they lack enough savings to cover three months’ worth of living expenses and do not have savings to allocate toward future expenditures like buying a home or paying for a child’s college education.
But even those who succeed at starting an emergency savings account can fall victim to depleting their funds for the wrong reasons.
It’s easy to fall into the habit of thinking that every bill you’re faced with is an urgent expense your day-to-day checking account cannot bear to handle. Knowing how to decipher a true financial emergency from just another bill is important if you expect to continue growing your savings.
Common Reasons People Tap Into Their Emergency Funds
There are many different reasons why people dip into their emergency savings funds. Some use the account as a general savings account that clumps emergency funds and personal goals like saving for a home down payment or wedding into one fund, while others make the mistake of using their emergency money as a second checking account.
Finally, there are a few individuals who use their emergency funds as originally intended: to protect against an unforeseen expense that is unavoidable and time sensitive. Our friends at Money Crashers know exactly what this level of financial urgency entails, as David Bakke explains his impetus for using his emergency money.
A Good Reason: Unemployment
“A few years back I used my emergency fund because of an unexpected job loss,” Bakke said. “Luckily at the time, I had three months’ worth of living expenses set aside, and that ended up being exactly how long I was out of work. So things worked out perfectly for me in that situation.”
In this scenario, Bakke was faced with both an unavoidable and time-sensitive financial dilemma. The unexpected loss of income he experienced was alleviated by his robust emergency savings account, which allowed him to stay financially steady until he found another job.
When asked whether it was the right decision to use his emergency funds in this circumstance, Bakke said, “I do feel like it was a good decision, because it involved a legitimate emergency. People have to decide for themselves what constitutes a valid emergency and what doesn’t, but they should understand that it should be limited to unforeseen circumstances.”
An event like what David experienced is a valid reason for dipping into one’s emergency fund, but then there are people like me.
A Bad Reason: Frivolous Expenses
During college, I lived well beyond my means, and often used the convenience of instant fund transfers from my savings account to my checking account when I was in jeopardy of overdraft fees. My emergency savings account — which held my extra student loan money — in a sense acted like my backup checking account. If my primary checking account had a zero balance, I could just schedule a one-time transfer of my emergency money into my checking account and problem solved.
Little did I know (or care) that I was essentially living the high life with borrowed money. Looking back at my financial misadventures, I recognize I was able to justify this emergency savings account approach solely because it was urgent; after all, if I didn’t use my savings then I’d get hit with an insufficient funds fee.
But being able to discern a financial emergency from a financial want can be a blurry distinction.
When Is It Appropriate to Use Emergency Funds?
Learning what is considered an emergency is the first step to protecting your savings funds should a real emergency arise. While unique and challenging circumstances can cause you to second guess whether you’re making the right choice in withdrawing your emergency funds for an expense, most situations that merit the use of an emergency savings account have both components mentioned in Bakke’s situation: The expense must be unavoidable and urgent.
What does this mean, exactly?
- Unavoidable expenses are those that you could not possibly foresee and often cannot dodge. Examples include getting laid off, losing an income source (e.g. spouse loses job), broken leg that needs surgery, car accident that totals the vehicle.
- Urgent financial matters must be paid for within the month. Instances of urgent expenses include those previously classified as unavoidable. Examples of expenses that are not urgent include a down payment for a new car, footing the bill for a birthday party dinner and wedding costs — all of which are easily foreseeable and can be postponed based on need.
Since everyone’s financial obligations and daily obstacles can vary dramatically, being able to differentiate between what is considered an emergency is understandably hard to measure. There is no right answer for everyone. However, by knowing which expenses can be addressed simply by shifting day-to-day spending, you’ll be better adept at knowing when to break the lock off of your emergency savings fund.
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