Not all expenses are an emergency
How to Know When to Use Your Emergency Fund
by Jeffrey Morris
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One of the more popular personal finance debates is the importance of an emergency fund. Personal finance writers and enthusiasts alike seem to agree that an emergency fund is an essential component of a good financial plan. According to a survey by GOBankingRates.com, 30% of Americans do not have an emergency fund at all. Among those that have one, 69% have approximately $1000 in an emergency fund, 10% have approximately $4500, 5% have approximately $7500, and 14% have more than $10,000 in an emergency fund. Greg McBride, a chief financial analyst with Bankrate.com, is of the opinion that when building an emergency fund, one should aim for an amount that would cover six months' worth of expenses.
The purpose of an emergency fund is to enable a person to get through financial emergencies without incurring debt. An issue that hasn't been discussed is how to determine what type of event justifies using the emergency fund. There are certain questions you should ask yourself before you spend your emergency fund.
Is the "emergency" a want or a need? A lot of people cannot draw the line between something that is required and something that is desired. If you are in need of funds for a medical procedure, then you have a need that qualifies as an emergency. On the other hand, a new iPad is a want that is not worthy of your emergency fund.
Was the "emergency" expected and you had a long time to prepare? If so, don't dip into your emergency fund. Take, for instance, that you are throwing a birthday party. You knew in advance and you could have planned for it. Do not dip into your emergency fund for that purpose, as it is unwise.
Is the "emergency" urgent? I understand that a faulty car may require your emergency fund. You need to get to work. On the other hand, buying floor mats for the car wouldn't qualify.
Can you defer payment for that "emergency" or pay in installments? If your heat pump breaks down in winter, it is an emergency, but many companies will let you pay over a number of months. If they're not charging you interest, it is better to make payments as compared to hitting your emergency fund.
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Does the "emergency" bear financial or other severe consequences? An unrepaired leaky roof will lead to more expensive damage to your home. Not spending a dollar now will cost many dollars later.
Finally, the argument of Professor Harold Pollack, a University of Chicago Professor and co-author of the book The Index Card: Why Personal Finance Doesn't Have to be Complicated summed it up when he said, "You should spend your emergency fund if spending it would leave you in a better overall financial position."
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