Over the years you managed to save up for a rainy day. Good on you! This is an accomplishment worth celebrating because not everyone is able to save money. But what exactly is considered a rainy day? When do you tap into that buffer?
I can help you decide when to use – or not use – your emergency fund.
What’s up with your financial situation?
Wether you are planning to start investing or not, it is always a good idea to have a closer look at your financial situation. Determining where you are at is the first step of moving forward.
Analyze your spending behavior, check what goes out versus what comes in, and establish an emergency fund.
Enter: emergency fund
What is it?
An emergency fund is a cash buffer for when anything goes wrong.
Keeping your money 100% invested is not the best idea, you need to keep some cash at hand. You could save for short term goals (such as the purchase of a house, renovating the bath room, a trip, a wedding…) but you also need to save for emergencies.
Where do you keep your cash buffer?
You’re going to keep your buffer in a savings account. If you are able to find one with a high interest rate that’s awesome, but nowadays it’s nearly impossible to find a high yield account.
Do NOT keep the money in your checking account. This account is for daily expenses only: groceries, bills, going out… It might sound obvious but you don’t want to know how many times I have seen people stash their whole capital in an active checking account.
Why is keeping an emergency fund in your checking account a bad idea?
- There is no way whatsoever of telling your active budget and your savings apart.
- It is way too tempting to spend your savings if you have direct access to them through a debit or credit card.
- If you were to become a victim of phishing or fraud – I truly hope this never happens but better safe than sorry – you don’t want them to have easy access to all of your money.
How much money should an emergency fund contain?
Your emergency fund should contain 3 to 6 months worth of expenses. That’s the general rule of thumb, but I personally think 6 months is a lot. I prefer 3 months because of inflation, but you have to find out for yourself what amount you are comfortable with. If you feel more secure having 5 or 6 months worth of expenses as a buffer, by all means, stick to that. I would recommend 6 months as a maximum though, unless you are saving for a large project.
Having trouble building your emergency fund?
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What is an emergency?
When is a good time or occasion to actually use the money you saved? Let’s start by defining what an emergency is:
An emergency is a serious, unexpected, and often dangerous situation requiring immediate action.
Serious → the event is not to be taken lightly
Unexpected → you couldn’t foresee this happening and were unable to prepare
Dangerous → the event is impacting your life in a negative way
Requiring immediate action → you need to make an urgent decision
These are the objective criteria, but of course an emergency can look different to everyone. These 3 questions will help you decide what an emergency is to you:
- What is the impact on my life if I don’t spend money on this right now?
- Is the emergency serious? In other words: are we in the ‘must have’ category or the ‘nice to have’ category.
- Is there an alternative? Can I get the money somewhere else?
Example:
my washing machine breaks down.
- Impact: for me, a washing machine is very important. I used to not have a washing machine when I just moved out of my parents’ house and I know now what a luxury it is to do your laundry at home. I couldn’t live without it anymore, so my machine breaking down seriously impacts my life.
- Must have or nice to have: for me this is a must have. I do not have time to run to a laundry salon and wait for my laundry to be done.
- Alternative: can I put in extra hours at work or make extra money some other way on short notice? If that’s not the case, I will use my emergency fund.
Examples of must haves:
- Fridge breaks down: you need a fridge to store your food. Without it, it will go bad.
- Period of illness: sometimes you need to prioritize your health (mental and physical) and take a paycut. It’s absolutely fine to use your emergency fund for this.
- Income disappears: losing your job is an emergency worth using your buffer for. Your savings literally buy you time to find a new job.
They say money doesn’t buy happiness. It’s true that counting the money in your account doesn’t make you happy. But when going through a stressful time you don’t want any added financial stress.
When to not use your emergency fund?
Nice to haves are not emergencies. Maybe I am stating the obvious, but you would be surprised how many people use their savings to buy a pair of expensive boots.
For your information: I’ll be the first to admit that boots can make you happy. But financial stress doesn’t, please keep that in mind.
Examples of nice to haves:
- An expensive purse or piece of designer clothing.
- A new phone (when the old one isn’t broken).
- A pleasure trip that you know you cannot afford.
What happens after you have used cash from your emergency fund?
This is important! Once you have spent the money: let it go. Most of us dislike spending money because it hurts us. But being able to pay for emergencies is exactly why we build a buffer.
Don’t go wallowing in self pity because you lost money. This is what you have been saving for and what the purpose of money is. Cash wasn’t made to sit in your account for you to look at. Step away from the scarcity mindset, it’s liberating.
Instead of being scared of spending, try saying this to yourself:
“I am grateful that I am able to pay for this.“
“I am grateful that I have money to take care of myself.”
You’ll see, your mindset will follow.
P.s.: Are you eager to learn more about investing? Check out my online course “Newbie to investor”. It contains everything you need to know to get started.
