“Emergency Fund: Do You Really Need One?” is a post by Adina J, a freelance writer, TimelessFinance contributor, and author of Blue collar / Red lipstick.
Wait, don’t run away! I promise this is not one of those emergency fund posts. Notice the question mark in the title? It’s there for a reason. So hear me out … pretty please?
When I first started reading PF blogs (and by that, I mean Gail Vaz Oxlade’s blog), I was immediately receptive to the idea of an “emergency fund”. I am ALL about saving for a rainy day – multiple rainy days, in fact. I swear, I’m not a pessimist; nor am I a meteorologist. But when it comes to looking into the future, all I can seem to see are clouds. I’m all about the negative “what ifs” because the positives … well, they take care of themselves, don’t they? As I got more involved with the PF “crowd”, the regularity with which the words “emergency fund” kept coming up reassured me that I was on to something. The “emergency fund” is where it’s at.
Or is it?
As I gained more familiarity with the subject matter, and began to think about it more critically, I started to question the wisdom of the “emergency fund” – and for a number of reasons. First, the poor thing is misused, or downright abused, to no end. “Emergency” means different things to different people. This fluidity in interpretation results from two things. One: the definition of “emergency” is tied to the concept of necessity. Lots of people have difficulty characterizing “necessity” in a way that doesn’t expand its meaning to the point of meaninglessness. Ergo, an emergency can easily encompass anything from a child’s life-threatening illness to a dishwasher malfunction. (No, you don’t need a dishwasher. Ditto a TV. Ditto an iPhone. I could go on.) Two: the definition of “emergency” is dependent on a person’s overall financial situation. For some people, nothing short of a work-impairing illness (not covered by sick pay or insurance), or a similarly life-changing event, might qualify as a true emergency. For someone living paycheque to paycheque, a broken taillight might qualify.
Let me state the obvious. Regardless of what your definition of “emergency” might be, you need to have savings to cover the possibility of adverse event(s) arising. If your definition is too extensive for your income to keep up – in other words, if you are already too over-extended to maintain the same level of lifestyle indefinitely – then that’s a separate problem. I’m sure that Joe probably has some ideas for you. Back to the topic at hand: if you have a car, you need to be prepared for the costs of its maintenance and eventual replacement. If you have a job, you have to have a plan to address job loss. There is, obviously, a financial cost to all of these things.
But, you will say, if I adopt this approach, my “emergency fund” would be so much greater than what the PF gods dictate is prudent. (This varies, endlessly, by the way. I think 3 to 6 months’ worth of fixed expenses is a popular threshold). And you would be right. Because an emergency fund is not enough. Or, more precisely, an emergency fund is not the ideal way to approach the problem posed by rainy days.
Think of rainy days as risk. Risk of illness, risk of unemployment, risk of car problems, risk of house problems … you name it, it’s all risk. You need to have insurance to cover off all of those foreseeable risks. For the catastrophic risks, you may be able to (and should) purchase an actual insurance policy (long-term disability, death, house fires and floods, etc.). Others will require that you self-insure. The only way to do that – you guessed it – is by saving. The amount you will need to save will depend the risks to which you are exposed. A car-less person has different exposure than someone who has a car; someone who drives a 2000 Honda has different exposure than a person driving a brand new Ferrari. In other words, the more costly your lifestyle, the more money you will need to save to ensure you can continue to live the same way without debt.
Obviously, not all risk materializes simultaneously (unless you are the world’s unluckiest person); with some exceptions, most risks have a foreseeable timeline. You must always, at a minimum, insure yourself for the unpredictable risks. As for the rest, you must anticipate the likely timing of the manifestation of the risk by ramping up savings to meet it. Your car breaking down is unpredictable; you will need a chunk of change handy at all times to cover off routine types of repair (calculated with regard to your particular model). Your car needing to eventually be replaced is a foreseeable eventuality; you will need to honestly assess the likely timeline of its demise, and start saving in anticipation as early (or as late) as your other constraints demand. And by other constraints, I mean the other, concurrent savings goals you might have.
Which brings me to my next point: savings is a fluctuating target. Some years, you will need to save more; some years, you may be able to get away with less. When savings get depleted, as risks materialize and require outlays of cash, they need to be replenished. And on the rare occasion when you’re all topped up with extra cash in hand … well, I’m sure no one requires guidance on spending discretionary income. (If you do, I would be happy to provide assistance, for a very reasonable fee.)
The main reason why the concept of “emergency fund”, as commonly understood in the PF world, falls short is that it barely begins to cover the risks to which most people are exposed. If you are very, very lucky (and with extensive actual insurance to boot), you may be able to successfully navigate life’s rainy days by relying on only a small umbrella of cash, like the much-vaunted 3-6 months’ worth of expenses. That is, only as long as rainy days are few and far between – only one or two small “emergencies” popping up at the same time – and you are diligent about patching up your umbrella after each storm. This approach is better than heading into a meteorologically unpredictable future with nary a rain-jacket, but it’s only marginally so. One bad storm, and you’ll be left with only the tatters of your financial security. It’s better to build a proper rain shelter, and while you’re at it, make sure it’s got proper insulation and drainage.
Silly metaphors aside, the answer is simple: save. As long as you can do it, don’t stop saving. You can never have too much in your savings accounts (Editor Joe’s note: yay! Thanks for justifying my ridiculous savings rate). You can, however, have too little. Don’t allow yourself to get complacent because you’ve accumulated an arbitrary amount that some blog told you is the magic number. Congratulations – now keep saving. So what if your umbrella is bigger than your neighbour’s? You’re both going to get hosed some time or another.