Should Emergency Funds be Used for Infrequent, but Likely, Expenses?

Question

Say we break down non-monthly costs into the following three categories.

• High level of predictability: This would include oil changes that may be needed every 2 to 4 months depending on usage, car insurance (if paid every 6 month), car registration, etc.
• Medium level of predictability: There are some expense which one can reasonable assume will occur on an infrequent basis. For example, car repairs, house repairs, or even doctor visits during flu season.
• Low level of predictability: For example, losing a job, significant medical expense, etc.

Which of these categories are emergency funds meant to cover?

I think it is pretty clear that a high level of predictability costs should not use emergency funds while a low level of predictability should. But medium level of predictability costs seem different, and it left me wondering what is generally defined as an "emergency". While you do not know when these costs will occur or how much they will be, you could devise some pretty good rules of thumb on frequency and cost. Say you know your 2007 Volvo should have a repair cost averaging out to $100 per month. Conceptually you could save $100 each month and when your car breaks, not have to spend any emergency funds on the repair. Is doing this "double-saving" and not suggested if you already have the 6 month emergency fund saved up?

Note: this is a question on how to save money for expenses. It is not a question about if you should spend emergency fund money to fix a car when you have no other money set aside.

Answer 1

Which of these categories are emergency funds meant to cover?

Emergency funds are for emergencies, which to me means expenses that are unanticipated and can't be covered out of "normal" cash-flow. Oil changes are not an "emergency" and should be part of your normal budget. Car/house repairs and doctor visits might be an emergency depending on the severity and the urgency (e.g. do I need to fix this now or can I save up and fix it?)

For known, predictable expenses that are infrequent (Christmas, birthdays, car insurance, home insurance/taxes if it's not part of your mortgage payment), I use an escrow account. I calculate how much I'll need for all of those things put together over the year and set aside a fixed amount each paycheck to ensure that I have enough to cover each item. You could do something similar for minor doctor visits, car repairs, etc. Estimate how much you might spend and set aside some money each month. If you find you're spending more than you thought, just increase the amount. You can use envelopes for each type of expense, have a separate checking account for those, whatever. The point is to set it aside and make sure you have enough left over to cover your known expenses.

The whole point of an emergency fund is to be able to pay cash for emergencies rather than borrowing to pay them and dealing with interest, late fees, etc.

Answer 2

The concept of emergency fund is a matter of opinion. I can tell you the consensus is that one should have 6-9 months worth of expenses kept as liquid cash. This is meant to cover literally all bills that you might encounter during that time.

That's a lot of money. There are levels of savings that are shy of this but still responsible. Not enough to cover too much in case of job loss, but enough to cover the busted transmission, the broken water heater, etc. this is still more than many people have saved up, but it's a worthy goal.

The doctor visit is probably the lowest level. Even without insurance, the clinic visit should be under $200, and this shouldn't cause you to have to carry that amount beyond the time the bill comes in.

The point that shouldn't be ignored is that if you owe money at 18% on a credit card, the emergency fund is costing you money, and is a bit misguided. I'd send every cent I could to the highest rate card and not have more than a few hundred $$ liquid until the cards were at zero.

Last - $5K, $10K in the emergency account is great, unless you are foregoing matched 401(k) dollars to do it. All just my opinion. Others here whom I respect might disagree with parts of my answer, and they'd be right.

Edit - Regarding the 'consensus 6-9 months' I suggest -

From Investopedia -

"...using the conservative recommendation to sock away eight months’ worth of living expenses...."

The article strongly support my range for the fact that it both cites consensus, yet disagrees with it.

From Money Under 30

The more difficult you rank your ability to find a new job, the more we suggest you save — up to a year’s worth of expenses if you think your income would be very difficult to replace.

From Bank of America

I have no issue with those comfortable with less. A dual income couple who is saving 30% of their income may very well survive one person losing a job with no need to tap savings, and any 'emergency' expense can come from next month's income. That couple may just need this month's bills in their checking account.

Answer 3

For me, the emergency fund is meant to cover unexpected, but necessary expenses that I didn't budget for. The emergency fund allows me to pay for these things without going into debt.

Let's say that my car breaks down, and I don't have any money in my budget for fixing it. I really need to get my car fixed, so I spend the money from my emergency fund.

However, cars break down periodically. If I was doing a better job with my budget, I would allocate some money each month into a "car repair/maintenance" category. (In fact, I actually do this.) With my budgeting software, I can look at how much I've spent on car repairs over the last year, and budget a monthly amount for car repair expenses. Even if I do this, I might end up short if I am unlucky. Emergency fund to the rescue!

If I'm budgeting correctly, I don't pay any regular bills out of this fund, as those are expected expenses. Car insurance, life insurance, and property tax are all bills that come on a regular basis, and I set aside money for each of these each month so that when the bill comes, I have the money ready to go.

The recommended size of an emergency fund is usually listed as "3 to 6 months of expenses." However, that is just a rough guideline. As you get better with your budget, you might find that you have a lower probability of needing it, and you can let your emergency fund fall to the lower end of the guideline range. The size of my own emergency fund is on the lower end of this scale. And if I have a true crisis (i.e. extended unemployment, severe family medical event), I can "rob" one of my other savings funds, such as my car replacement fund, vacation fund, etc.

Don't be afraid to spend your emergency fund money if you need it. If you have an unexpected, necessary expense that you have not budgeted for, use the emergency fund money. However, your goal should be to get to the point where you never have to use it, because you have adequately accounted for all of the expenses that you can reasonably expect to have in the future.

Answer 4

If you think about it, it's really all one big pot of money. The idea behind an "emergency fund" is that you want to make sure your financial life has stability: it's not going to be suddenly driven into the red, below $0. As long as that doesn't happen, you can figure out how to live your life as you want.

The reason we separate out an "emergency fund" is to simplify decision making. In theory, every single purchase you make should include a consideration of how it destabilizes you. Every $100 you spend on groceries is $100 you won't be able to bring to bear if you get fired or have a major accident. In practice, this would be a crippling way of thinking about things. You don't know what emergencies can hit you, nor when they will hit. That's why they're "emergencies." If you had to think about them all the time, it'd be horrible! You would end up simply not thinking about it (like most people), and then the emergency hits when you don't have enough cash to stay solvent.

The purpose of an "emergency fund" is to help make these decisions easier. If you have money set aside for "emergencies" that you only have to think about every now and then, you can make the decisions in the rest of your financial life without too much concern for them. You don't have to worry about that $100 in groceries because you are confident that if an emergency hits, that $100 won't be the straw that broke the camel's back because you have reserves to draw on.

So you should define an "emergency fund" in a way which is most helpful for you to remain stable and solvent without having to fret about it too much. For most people, the criteria for tapping that fund is very high, because the goal is to not have to think about it all that much. If you wanted to, you could feel free to lump those "medium predictability" items into the emergency fund, but it just means you have to spend more time and effort thinking about the state of the fund. Every medium predictability purchase has to come with the thought process "what is the state of the emergency fund? Could this purchase meaningfully destabilize my ability to handle emergencies?" Your emergency fund might yo-yo under these extra purchases, which could force you to think about the state of your emergency fund for normal purchases. That'd be bad.

Different people might want to think about things different ways. I'm a big-picture guy, so I prefer to think about all of my assets as one big account when I make a lot of my decisions. My wife, on the other hand, prefers not to have to think that way when she makes her purchases. For her, having a very discrete "emergency fund" has great value. For me, it has less. So when I look at the finances, I choose to lump the emergency funds in with, say, the funds to re-do our backyard (something we are looking at doing over the next 2-5 years). For me, that is the most natural way to deal with analyzing the risks -- I just have to be aware of how backyard purchases interact with our safety net. My wife prefers to keep those funds separate in her head, so that she can look at how to spend money on the backyard without thinking about how it affects our emergency readiness. While complicated, it shows that even within a household, it's possible to think about emergency funding two different ways. (it causes minimal headaches, though a fair bit of book-keeping)

So define "emergency fund" however suits you and your life best. However, practically speaking, most people find it desirable to not put those medium predictability purchases into the same bucket as emergencies. Those that do find it desirable to put them in the same bucket typically have a personal reason for why that suits their needs better.

Answer 5

I think it's wise to account for those inevitable but unpredictable expenses like car/house repairs and abnormal medical bills when deciding on your emergency fund amount.

So if you average $100/month for car repairs, and you have a 6-month emergency fund, then part of that fund is $600 for car repairs. If your total annual out of pocket for health insurance is $5,000/year, then emergency fund gets $2,500 and so on. This way, you add cushion to your emergency fund to handle those unpredictable but inevitable expenses without setting up a bunch of separate accounts.

It doesn't have to be inflexible either, I know my furnace and air conditioner are way past their expected life, so I'm keeping a larger than normal emergency fund.

Ultimately it's personal preference, to me, cash is all the same no matter what account it's in, but other people do best by keeping some logical/physical separation of funds intended for different purposes.

Answer 6

This is probably a very opinion-based Q&A. But anyway:

My solution to such questions is to have multiple layers of emergency funds.

I have one amount in a bank account that I do not like to tap, but can (and do) when I need money. This is most close to your infrequent but not completely surprising moments of cash need.

I have a second layer in the form of stocks. As I understand that selling stocks should not be done when you need money, but when the stock price is good, this provides a fairly high barrier to selling it on a whim. Before I do so, especially if the stock price isn't at a local max, it would have to be an emergency.

My third layer is even more fixed investment which I can't access with online brokerage. The physical aspect makes sure that it has to be a real, serious emergency before I turn that into cash.

If you have such a layered approach, the question is not black and white anymore, and easier to answer.

Answer 7

I don't think there is a definite single answer for this. I think it largely depends on where you are on your financial journey. In the ideal world you'd have everything in bucket 2 built into your budget and be putting a little bit aside every paycheck to cover each of those things when they do come up but that takes a fair bit of discipline to do and experience (and data) to estimate reasonably.

When you are just starting out in actually setting and keeping a budget or digging yourself out of CC debt/living paycheck to paycheck the odds are you aren't going to have the experience or disciple necessary to actually budget for those things in bucket 2 and even if you did the better option might well be to pay off that high interest debt you already have rather than saving up for an eventual expense.

How ever as you start to improve your situation and pay off that debt, develop the disciple to set and follow a budget that is when you should start adding more of those things into your budget. How you track them doesn't really matter. A separate account at your bank. A total for a category in your budgeting software. An XLS file or even paper (ick). Ultimately it isn't about how you plan for and track things but more about actually doing that.

So my question to the OP is where are you? If you already have a budget and do a good job of following it but don't have those items in it then consider that the next step in your financial journey.

Answer 8

I would suggest that you use Emergency Funds for things that have a Low likelihood of happening but if they do happen can be devastating. I used to work as a financial advisor and the sugfestion we gave people is to have about 3 months worth of expenses in cash. This was primarily to cover things luke loss of work or some unforseen even that would prevent you from missing work for an extended period of time. Once you have your emergency fund saved do not touch it! Leave it where it is. Then tou can start working on a savings account for those items that are more likely to happen but dont have as much of a negative impact.