The Myth About an Emergency Fund and Why You don’t Need One

Read any blog, web site or book dealing with personal finances and you are bound to find one or many pages written about the necessity of having an EMERGENCY fund … The advice ranges from few hundret to start with to the equivalent of 6-12 months expenses.

Continue searching and reading comments on this topic and you will soon discover that most people don’t have such a fund and those who try to have one struggle with: defining its size, knowing when to use it, keeping paying into it in the longer run.

And is if it was not enough there are further considerations like: do I pay into an emergency fund or do I re-pay my debt first? Do I have to have it in cash or in one of mine accounts? What is more important my emergency fund or my retirement fund?



For most people to physically save 5, 10, 15 or 20 thousand dollars/pounds/euros on top of everything else that needs to be taken care of (like your pention, debt, education, etc.) is nearly impossible.

Hence this goal is demotivating and destructive. It’s easy to think – “what’s the point of budgeting, saving, planning my finances if I can’t even provide a safety net in the next three, five, ten years time” (fill in the time it will take YOU to save up that ridiculous amount of money)

I vehemently oppose the whole idea of vast amounts of money tucked away in cash or in low interest savings accounts!

I don’t suggest you don’t have any savings, no! I suggest that you break down your emergency fund monster into manageable chunks of money being saved for different purposes, available on different terms and that you substitute some of your possible saving goals with insurance products.

Pictures are better than words, so here is my hierarchy of emergency funds

Cash Flow

Half of an average of your overspend in the last six months – this is something you should aim to have in your account by the end of the month – each month. – Why? Nothing motivates you more to stick to your budget, keep saving, control your spending, etc. then your current account floating above “0”.

In our case it’s about £200.

This one should cover unplanned minor expenses like shoe repairs, speeding tickets, new toaster and alike (I refuse to get anal and plan (aka save in advance) for this minor crap)

Repairs

Look around your house. What do you have that’s likely to break down and is not covered by warranty? (In our case it’s: heating, appliances, water boiler). How old is this stuff? How much do you think it might cost to repair it?

In our case – I’ve estimated £800 (excluding car)

Other Emergencies

That’s the first part of your “truly emergency” fund. Money for larger, unpredictable expenses. This is an area where you would struggle to come up with an example quickly as this pot of money should cover unpredictable and unanticipated costs, nothing else.

I hope to save here £1500

Long-term Fund

That’s the one that should help you in case of illness and unemployment. To cover for unexpected death I personally opt out for a life insurance. I would estimate 4,000 to 6,000 here.

By the way - the amount you need to save here depends on how many people work in your household now and how many could start working/increase earning if need be. Don't "over-save" just because you don't want to challenge a potential status quo!

Other Stuff

I have an extra car repair saving goal as it is likely that something needing attention will happen each year (latest at the next inspection) and I also have “irregular bills” category in my budget – even if I am paying for something once in a year I can be saving money for it for at least 11 months prior, can’t I?

Where to Get Money From?

My approach to this is quite flexible.

Cash-flow: spending discipline on a monthly basis, I've budgeted for an “underspend“

Repairs and irregular bills: I have listed all irregular bills for the upcoming year and dates they are due - each bill contributes its amount to the overall amount of money saved each month into this category based on its size and due date. Repairs is a rough estimate.
My irregular bills will all be paid by April this year but I will continue to save the same amount of money going forward until I have £500.

Once I've reached this mark I will save for the next year irregular bills and than divert my monthly contribution to the "other emergency" goal.

My "other emergency" and "long-term" both receive equal amount of money (£100 each). That's not much but the idea is to contribute more when additional money becomes available.

The worst possible scenario of a sudden death is covered by a life insurance.

The only vulnerability we are not prepared for is the long-term sickness/disability... I'll worry about this one later. But right now I am considering different options and in particular I am thinking about taking out income protection and life insurance for me and my husband.

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