The annual Federal Reserve’s Report on the Economic Well-Being of US Households shows improvement each year in the number of Americans who could cover an unexpected $400 expense using cash (including savings or a credit card paid off by the due date.) It was 50% in 2013, increased to 63% in 2019.
The report still shows that many Americans have financial fragility, with 16% unable to pay their current month’s bills in full and an additional 12% unable to pay their current month’s bills in full if they had an unexpected $400 expense. A quarter of those surveyed skipped medical care in the prior year because they couldn’t afford it. These statistics indicate that about a third or more of us are living with financial stress and are unable to afford to take care of our health needs.
Americans who would not be able to pay for an unexpected expense would have to use debt, borrow money from loved ones, sell something, or pay another bill late. Since we can count on having unexpected or badly timed expenses, it’s important that we take charge of our financial peace of mind by creating a plan to deal with them.
Start with defining what an emergency (or badly timed) expense is or is not. Most of us would agree that an emergency visit to urgent care, the dentist, or the vet is an emergency. Broken appliances are a common emergency—some we may be able to delay fixing or purchasing, but not for very long. Air conditioners break during the summer in Phoenix, and there is little choice but to have them repaired or replaced. Depending on your mechanical ability, various car issues may be unexpected, but the repair would be an emergency expense, especially if you rely on your vehicle for employment. The same would apply to cell phones and other technology many of us use at least partially for work.
On the other hand, when you know that an appliance is going to need to be replaced soon based on its age (and maybe that weird sound), you might have time to save up for it. You know your tires will have to be replaced occasionally. If you live in the Phoenix area, you know your car battery will need to be replaced regularly, and your windshield wipers that are almost never used will be useless if you don’t replace them before monsoon season. When something you really want goes on sale, and you haven’t saved up for it yet, that is maybe unlucky, but it’s not an emergency.
An emergency fund, or rainy-day fund, is an account separate from the account you use for normal spending. The emergency fund account should be accessible enough that you can use it for an emergency, but difficult enough to access so that you don’t spend it for a non-emergency.
The standard guideline is to have enough money to cover 3 to 6 months of expenses. I would like to differentiate that type of fund—to cover the loss of income—from the emergency fund for unexpected expenses. If you have enough saved for both purposes, by all means, combine them. If you are still working on one or the other, it might be best to have a “freedom” fund (for quitting or losing your job) and an “oh-no” or “oops” fund for those emergencies and ill-timed expenses.
If you have no savings, begin with the “oh-no” fund. Start with the most you can commit to each week or pay period. While you can always add more, it’s important that you start with an amount you can consistently save so that you develop the habit and confidence that you can save for the needs of future you.
Making the savings automatic will make it easier for you to successfully fund your “oh-no” fund. Small amounts add up. If you get paid every other week (bi-weekly in the graph) and save $10 per paycheck, you will have $260; if you can increase that amount to $20, you will have $520 in one year. That is enough to cover the hypothetical unexpected expense in the Fed’s survey.
If you get paid every week, you will have that same $520 by saving $10 each pay period. By increasing the savings to $20 every week, you would have $1,040. If you wanted to save enough for both your “oh-no” and “freedom” funds, a larger savings amount could be appropriate if you can afford it and have paid off your debt. You could save $2,600 in one year by saving $50 every week.
If this is the first time you are funding an emergency fund, start small for a few months. See how that first 13 weeks looks and feels. Are you really missing that transfer to your savings account? At $10/week savings, you have $130; if you are paid every other week, you have $60 for the six pay periods.
Can you increase that weekly (or bi-weekly) amount another $10? If you can increase your $10 savings rate by $10 every quarter, you could have $660 for bi-weekly savers or $1,300 for weekly savers.
How does it feel to see how much you have saved so far? Celebrate your success by renaming your fund something fun.
What are you going to name your account? Are you team whealthiness goals or team piggy bank?
Virginia Asher, MSAFP, CFP®
My whealthiness journey has taught me that there is not one single way for us to live a prosperous life. I'll share what I've learned to help you find your way.