Congratulations – you’ve got an emergency fund for those unexpected expenses that will crop up occasionally!
Mistake #1: Never invest your emergency savings.
As tempting as it may be to invest your emergency money, don’t. Just don’t. It is an emergency money for a reason; it does not take rocket science to figure out that it’s NOT FOR INVESTMENTS.
Remember that the money you invest is always subject to some amount of volatility and risk, which makes it suitable for your long-term financial goals only.
If you invest emergency money, its value could plummet at the exact moment you desperately need it.
So remember that the purpose of an emergency fund is to keep you safe and give you financial security if your doorstep is darkened by an unexpected, devastating financial hardship, such as the loss of a job or an illness.
Tip: Invest money that you can throw away. It means that you must invest the money you can afford to lose. By that I mean, you won’t be in too much trouble if you don’t get the money you invested back.
Mistake #2: Don’t let your emergency savings sit idle.
Don’t take the opposite approach with your emergency money and tuck it under the mattress.
While you may want to keep some amount of cash at home in a fireproof safe, it’s best to keep most of it in an PDIC-insured, high-yield bank account.
Again, do not invest your emergency savings. Put it in an insured bank with high-interest rates. Again, it’s named Emergency Savings, because it is not supposed to go to your investment portfolio; it’s supposed to go to a savings account.
Mistake #3: Don’t spend emergency savings on non-emergencies.
Be disciplined with your emergency money and never touch it except in a dire emergency! The amount of money you should keep in your emergency fund depends on your job and family situation.
I recommend that you maintain at least 3 to 6 months’ worth of living expenses at all times. So unless buying a car is a true emergency that Lori has no way to finance without tapping her emergency money, she should find another way to pay for it.
Remember that whole point in having a financial safety net is to give you peace of mind and confidence that no matter what happens in your financial life, you’re prepared for it.
How will you know when to dip into it? Ask yourself these three questions. If you can answer Yes to all three – it’s a legit emergency. If you can’t, you may be sabotaging your financial freedom.
1. Is it an unexpected expense?
There are some things in life you can’t plan for:
- getting laid off from work
- an unplanned pregnancy
- being unable to work due to health issues
- leaky pipes causing water damage
You’re still going to have bills to pay if you get laid off from your job. But with an emergency fund you can continue to pay the mortgage, eat three meals a day, and buy gas for the car while finding your next great job. You won’t be stressed knowing you have a cash cushion to keep you afloat.
Expenses that you forgot to budget for or are recurring expenses aren’t emergencies. Such as the following:
- birthday/anniversary/Christmas presents
- property taxes
- back-to-school shopping
- visits to the vet
Kids always go back-to-school. Fido always needs shots once-a-year. Christmas is always in December. Property taxes are always due in January.
Budgeting for recurring expenses will make sure your emergency fund is left intact for real emergencies.
2. Is it a need?
People often confuse needs and wants. It’s easy to do. We can talk our brain into believing just about anything.
However needs and wants are light-years apart. They are like daytime and nighttime. Salt and pepper. Yin and Yang.
Needs are real emergencies.
Here are a few things you might want:
- Prom dress
- Lawnmower that’s on sale
- iPhone upgrade
- Dinner out when your friends are in town that you haven’t seen in 2 years
- Christmas gifts for the kids
- Victoria’s Secret semi-annual sale
I need a new car is only true if your current car:
- Will not start
- Will cost more to fix than the car is worth
Otherwise, you don’t need a new car; you just want one. And if you buy a new car every three to five years that’s something you should budget for by having a car fund.
If you have a car that drives, draining the emergency fund to purchase a new one is not an emergency.
Fixing a hole in your roof that’s leaking in the rain is a definite need. Painting the exterior of the house because you no longer like the color is a want.
Don’t sacrifice long-term savings for short term pleasures.
3. Is it urgent?
Ask yourself if the situation is time-sensitive or if it can wait.
Medical issues are usually urgent, but sometimes they aren’t.
Airplane tickets for a beach vacation that are on sale are not urgent. Why not? Vacations shouldn’t come out of your emergency fund – they aren’t emergencies. Even if your kids are driving you crazy – you need a vacation or you’re just going to explode – it’s still not an emergency. Like a new car, vacations come from a fund set aside for that purpose.
The furniture sale that ends next week isn’t an excuse to use your emergency fund for a new leather couch and loveseat. If you want new furniture, create an opportunity fund and build it up until you have the cash to buy it in full.
What happens if you raid your emergency fund then lose your job? It’s not going to be very comfortable sitting on your leather couch on the sidewalk after you get foreclosed on and don’t have a house.
If you found a legit emergency, spend the money and don’t feel guilty. That’s why you have the emergency fund!
Ready To Be Rich. (2016). 9 Mistakes People Commit When Building an Emergency Fund. [online] Available at: https://fitzvillafuerte.com/9-mistakes-people-commit-building-emergency-fund.html [Accessed 15 Jul. 2017].
Hamm, T. (2010). Ten Big Mistakes #8: Credit Card as Emergency Fund – The Simple Dollar. [online] The Simple Dollar. Available at: http://www.thesimpledollar.com/ten-big-mistakes-8-credit-card-as-emergency-fund/ [Accessed 15 Jul. 2017].
Theweek.com. (2016). Building a rainy day fund? Avoid these 6 common mistakes.. [online] Available at: http://theweek.com/articles/648235/building-rainy-day-fund-avoid-6-common-mistakes [Accessed 15 Jul. 2017].