Our Emergency Fund
An emergency fund is for those unexpected events that are not regularly planned for happening in life - you lose your job, there's an unexpected pregnancy, the car's transmission goes out, or, or, or. David Ramsey
Unexpected events can be inconvenient, like the fridge breaking down; unexpected events can be really bad too, like getting into a mayor accident resulting in lifelong disability.
Regardless of the extent and impact of the event, there's enough to deal with already and one doesn't need added worries about getting cash nor prolonged and costly worries of paying back debts resulting out of the emergency.
The solution is fairly simple: setup an Emergency Fund. To do so we've come up with a few questions:
- How much should our EF be?
- How do we finance the emergency?
- How do we recover financially after an emergency?
How much should our Emergency Fund be?
Commonly this question is approached looking at how much you need to cover your costs over a three to six month period. A sensible approach which probably fits most people.
Although we don't have exact figures (yet), a quick estimate is we're currently using about € 1500 per month, resulting in an EF of six times 1500 = € 9.000. On top of that, as we're also using the EF to double as convenience breakdown buffer, we think about € 1.000 would be enough to cover that. And finally as this number is an estimate, adding 25% unforeseen is not a bad idea.
So we're ending up with a figure of € 12.500.
However, imo it is equally important to do a reverse calculation: how much would we need in a worst case scenario?
Suppose Nina finds a job in New Zealand and something would happen to my parents? Return tickets Auckland - Amsterdam about 2000 each, a hotel say 3000 for a month, another 1500 for renting a car plus gasoline, 500 for food, etc. It's adding up quickly and could surpass the 6 months buffer.
As we still live in the Netherlands, sticking to the 6 months rule is sufficient for now, but it is important to review the Emergency Fund after each mayor change.
The right amount will be different for everybody; I think 'enough' is defined by that amount which gives you the peace of mind you're looking for. Our € 12.500 feels comfortable, so it is enough for us.
How do we finance the emergency?
First of all we can use a credit card, currently with a € 2.500 limit. Also we have a current account (debit account) with a € 5.000 limit. On top of that, connected to the current account, is a savings account which holds the remaining € 5.000. This money can be transferred to the current account without delay. All in all if needed we have immediate access to the full € 12.500 of our Emergency Fund.
Although this scheme means we will get into debt, the point of the Emergency Fund is to prevent added financial worries on top of the emergency. In order to resolve the debt situation, we are going to store € 7.500 somewhere (currently on a savings account). This amount will cover both the credit card limit and the current account limit. This setup allows us to put those 7.500 somewhere without the need to have immediate access to it, which probably will lead to a higher interest rate. The only criterion is being able to transfer the money within a month.
How do we recover financially after an emergency?
Obviously it depends on the financial extend of the emergency. If we simply needed to buy a new fridge, than it's just a matter of waiting until next months salary comes in to fill up the Emergency Fund again.
But let's assume we've used the full € 12.500: The first step would be to use the € 7.500 to cover debts on both the current account and the credit card. Hereafter we should rebuild the € 5.000 on the savings account as soon as possible. This probably means we'll take whatever we've saved for short term goals and put it into the EF. The remainder will be added by postponing non essential expenditures on the next wage(s). The goal is to have the EF back in place within three months.
As for the € 7.500 stash, we'll slowly rebuild this over a 2,5 year period, thus saving € 250 per month. We are aware that this is a long period, but as the emergency fund itself is back in place again, it's not such a big deal.
Suppose a second big emergency happens, it could mean we'll go into debt without the ability to overcome that debt right away, thus indeed having the added and prolonged worry of coming out of debt. However, although not impossible, it's also not very likely two major emergencies occur in such a relative short period. We are aware of this and are willing to accept this debt as a possibility.
I guess this also means the first item on my 101-in-1001 list which is completed!
101-in-1001 #46: Setup an Emergency Fund
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#2 - 5 april 2012, 06:38
Depending on your emergency fund (EF) needs, split between the EF and the car loan. But the crux of the matter is not really how to divert your leftover savings, but how to increase those savings to erase your debt burden more quickly.Saving depends on1) Increasing Income (often less feasible).2) Decreasing Expenses (often more feasible).Most people focus on #1, and neglect #2. But most expenses can be decreased dramatically, or even eliminated. Share rent with lots of people, or live at home or in a low-cost area if possible, avoid owning cars in the near future (they suck a lot of money), eat out less, buy less (or better yet, nothing) or secondhand, don’t engage in expensive sports/hobbies, no travel/tech gadgets/brand names/movies, etc. Reduce all water, power, phone, mobile + cable bills to the minimum. Analyze your biggest expenses (usually rent/car/food/leisure/bills), and find ways to cut all the financial fat. Since you’ll have a lot of extra time on your hands, use it to invest in educating yourself and developing your professional talents/interests/skills so that you can achieve a higher future income potential. Go DIY – don’t pay others to teach you.Live poor – because actually, you ARE poor. By my personal definition, if you need a job in order to feed yourself, you’re poor. If you need to worry about what your boss thinks of you, you’re poor. If you’re in debt, you’re in the hole poor. Don’t be generous or ashamed – you literally can’t afford to be. Be generous and proud after you’ve saved up some $ $ $ . Extreme situations call for extreme measures. If you compare yourself to other people with lots of debt, you’ll feel your situation isn’t so bad, but you should be comparing yourself to people with positive net worth. I only make 18K/year now, but I save about 10,12K – more than 50% savings on income. I’ve been doing this for many years now, so it all adds up. So despite my low income, I had my basic 1K EF in my first month. I intentionally chose to live in a lower-cost city that didn’t require a car, and in the beginning I had to forego a lot of costly urban enjoyments (movies, dining, shopping, etc.). But the payoffs have been tremendous; I don’t worry about money or jobs. Plus, I only work part-time now. If you can find a way to save 1K a month, you’ll be well on your way. It’ll only take 20 months to pay off all your debts. If you have higher income and can save 1.5K, you only need 13 months to be completely debt-free.After you pay off your debts, you should continue your hardcore saving for a couple years, (1yr =12K, 2y=24K, 3y = 36K, depends on what your long-term financial goals are), after which you can invest your savings, and your money can start working for you, instead of you always working for money. Then you can ease off on or abandon the Spartan lifestyle. If you’re a guy, you might not want to though, because being a Spartan is actually pretty cool. It’s good mental & physical training, because it helps to cut away all the consumer materialist crap in life. Makes you focus on what’s really important in life – which is ironically, not the money, but yourself, your relationships, and your purpose in life. And coincidentally, all those 3 things suffer when you’re working the 9-to-5 grind and spending nearly all of your hard-earned money on whatever. Best wishes to you -
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#3 - 15 april 2012, 02:45
Here’s the thing: you need to be able to handle an emergency or unexpected expense if and when it arises. You can do this by having a pile of money in a money market fund (great) or by having availability on a low interest bearing credit card (good). You need to make sure you always fall into one of these catagories–or both, preferably. Don’t worry about your student loan debt if you have a low interest rate (below 6%). You might want to go ahead and try to pay your car loan down if you have a high rate (above 6%). I chose 6% because the best savings accounts/money markets are currently earning just over 5%. You’ll be doing better to pay down the debt if your savings rate will be lower than the interest you’re paying. Plus if you pay down the car loan, you will have a huge monthly expense gone, which will free up more income and lower your DTI ratio (which is good in case you want/need to get another loan, like a mortgage, anytime soon).
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#4 - 15 april 2012, 03:26
Do both as soon as possible with more emphasis on the emergency fund, then car loan, then student loan. I am guessing that your car is still driveable for at least two years. If so, add up all the deductibles on your insurance short-term disablility, health, car, life, renters etc. That is your emergency fund (should be around $ 1000), once you have that you will immediately feel a little better. Then go great guns to get the car debt paid off, nothing sucks worse than your car breaking down and still owing on it. Now save some $ for the next car (or at least down payment), still have time before the car dies? now knock out the student loans.Also, be sure you are adding $ 50 a month to a mutual fund Roth IRA from day one and start pitching into your 401k at work.
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#5 - 24 april 2012, 05:38
I would start a “baby” emergency fund of $ 1000. This will cover most emergencies except loss of a job. This is good finances as well as piece of mind.Second pat yourself on the back. You did accumulate debt, but not nearly as bad as others (myself included) and more importantly you want to pay it off.Next you need to promis to yourself that you will not accumulate more debt (outside of a house)Then pay the minimum on that student loan and attack the car loan with every extra cent you have until it is paid off, then attack the student loans.Don’t get mixed up in credit cards!!!!If you are a reader (or even if your not), check out Dave Ramsey’s “Total Money Makeover” It will detail out the steps to becoming debt free and wealthy – and it works
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#6 - 28 april 2012, 06:05
I would in this case pay off the car loan first. Its the least amount of debt, devote yourself to that goal first, then the school loans etc.. Start an emergency fund but have it deducted from your check through automatic deductions but start of with only $ 50 or $ 25 per check. (whatever you can afford) You’ve been without an emergency fund for this long, a couple of months won’t kill you. That’s what I would do. But to each his own..as they say…
Rajat
#1 - 4 april 2012, 15:51
Depending on your emergency fund (EF) needs, split weebten the EF and the car loan. But the crux of the matter is not really how to divert your leftover savings, but how to increase those savings to erase your debt burden more quickly.Saving depends on1) Increasing Income (often less feasible).2) Decreasing Expenses (often more feasible).Most people focus on #1, and neglect #2. But most expenses can be decreased dramatically, or even eliminated. Share rent with lots of people, or live at home or in a low-cost area if possible, avoid owning cars in the near future (they suck a lot of money), eat out less, buy less (or better yet, nothing) or secondhand, don't engage in expensive sports/hobbies, no travel/tech gadgets/brand names/movies, etc. Reduce all water, power, phone, mobile + cable bills to the minimum. Analyze your biggest expenses (usually rent/car/food/leisure/bills), and find ways to cut all the financial fat. Since you'll have a lot of extra time on your hands, use it to invest in educating yourself and developing your professional talents/interests/skills so that you can achieve a higher future income potential. Go DIY don't pay others to teach you.Live poor because actually, you ARE poor. By my personal definition, if you need a job in order to feed yourself, you're poor. If you need to worry about what your boss thinks of you, you're poor. If you're in debt, you're in the hole poor. Don't be generous or ashamed you literally can't afford to be. Be generous and proud after you've saved up some $ $ $ . Extreme situations call for extreme measures. If you compare yourself to other people with lots of debt, you'll feel your situation isn't so bad, but you should be comparing yourself to people with positive net worth. I only make 18K/year now, but I save about 10,12K more than 50% savings on income. I've been doing this for many years now, so it all adds up. So despite my low income, I had my basic 1K EF in my first month. I intentionally chose to live in a lower-cost city that didn't require a car, and in the beginning I had to forego a lot of costly urban enjoyments (movies, dining, shopping, etc.). But the payoffs have been tremendous; I don't worry about money or jobs. Plus, I only work part-time now. If you can find a way to save 1K a month, you'll be well on your way. It'll only take 20 months to pay off all your debts. If you have higher income and can save 1.5K, you only need 13 months to be completely debt-free.After you pay off your debts, you should continue your hardcore saving for a couple years, (1yr =12K, 2y=24K, 3y = 36K, depends on what your long-term financial goals are), after which you can invest your savings, and your money can start working for you, instead of you always working for money. Then you can ease off on or abandon the Spartan lifestyle. If you're a guy, you might not want to though, because being a Spartan is actually pretty cool. It's good mental physical training, because it helps to cut away all the consumer materialist crap in life. Makes you focus on what's really important in life which is ironically, not the money, but yourself, your relationships, and your purpose in life. And coincidentally, all those 3 things suffer when you're working the 9-to-5 grind and spending nearly all of your hard-earned money on whatever. Best wishes to you -