Why You Don’t Need An Emergency Fund
Talk to any financial planner, and they’ll suggest that one of the most important assets you can have is an emergency fund. “What if you lose your job? What if your car needs major repairs?” they’ll ask. The emergency fund is supposed to act as a safety net, helping you stay out of debt.
Media personalities also tout the importance of an emergency fund. Dave Ramsey recommends that you use some smart budgeting tips cover 3-6 months of expenses. Suze Orman recommends eight.
I believe there is a problem with an “emergency” fund. But before we get into that, let me first say that saving for the future is definitely important. In fact, financial planning is about saving for a future we hope to create.
With that said, I’m not sold on the idea of an emergency fund. Why? Because the term is too vague. And because of this vagueness, people define emergencies simply based on whatever circumstances pop up in their lives.
But if you can’t properly define an emergency, you’ll end up making random purchases using these funds and justifying them as “emergencies.”
Parkinson’s Law states that “expenditures rise to meet income.” So if you have income set aside for an emergency, the likelihood of an emergency will naturally increase.
In The Seven Habits of Highly Effective People, Stephen Covey defines the first habit as being proactive. Looking at his time management matrix, he suggests that focusing on the things that are important, but not yet urgent is the best mindset to be in.
“Emergency” expenses fit into this category.
So instead of random emergencies, it’s more helpful to anticipate possible future expenses, and save with that purpose specifically in mind. Then the likelihood of random emergencies should decrease.
This doesn’t deal specifically with an emergency fund, but one of the main reasons people stress its importance is because of its usefulness in the case of a sudden job loss.
But rarely are people in a state of total shock when they lose their jobs. Usually, rumors float around, people act funny in the office, and you can sense that the writing’s on the wall.
If that’s the case, doesn’t it make sense to put your resume out there the moment you sense trouble and get some feelers? That way, if you do get the boot from your employer, you’ve been one step ahead of them with little disruption in income.
Actual future expenses include household and auto repairs. Maybe your brake pads will need replacing in the future, or maybe you’ll need a new water heater or you need to get new tires (incidentally, go to Costco for your tires, they fill them with nitrogen – which is awesome)
If so, saving specifically for these items will help you focus your effort. And knowing the typical lifespan of these parts will give you a target date as to when you should have the money saved by.
For instance, household items such as a fridge, freezer, air conditioner, and water heater have a lifespan of about 15 years.
Cars batteries typically have a lifespan of 5 years. Brake pads last around 30,000 miles. Cars themselves usually last between 150,000 to 200,000.
Sample List of Future Expenses
- air conditioner
- brake pads
- water heater
- doctor visits
A Better Way To Save
The term “emergency” implies a lack of control. And though we can’t control or predict all future expenses, we can anticipate and save to the best of our ability.
Knowing this, it makes more sense to open one savings account, create sub-categories for each possible future expense, and save for all those expenses within that savings account. Everything will be organized in one convenient account, and you have a larger overall amount that compounds with interest.
Saving this way puts the “planning” back in financial planning.
So if you don’t have a savings account and would like to open one, ING Direct is offering a $25 bonus if you open an account with $250. The beauty of this account is that they have a feature which lets you create the sub-categories discussed. Contact me if you’re interested.
Do you think vague emergency funds are useful? What is an “emergency” to you? What categories of expenses do you think should be added to your savings account?