Here’s a wild idea: Let’s stop building one lump “emergency fund” and start building multiple smaller funds for the most common emergencies that occur over time. Every personal finance expert says you need to have a “rainy day fund” or “emergency fund” in place for when the unexpected happens. But, what does that mean for most people? What are the specific things that the average person ends up needing emergency fund money for?
So many people struggle with saving and it seems like every year there’s a new study that shows how unprepared Americans are for the most common emergencies. Instead of calling it an “emergency fund,” why don’t we get real specific and label this pile of money by the name of the specific situation it will most likely be used for. The three smaller emergency funds that an average professional should have are: car repairs, unexpected medical costs, and job loss.
Each year, the U.S. Bureau of Transportation shares statistics about all accidents that involve major modes of transportation. To most people’s surprise, driving a car is in the top two! While more people have a fear of flying, this is proven to be a bit irrational because statistics show that you are about 100 times LESS likely to be in an accident when traveling by plane than traveling by car. That means you have to be prepared to deal with not having a car in the event of a car accident or in a less severe case if your car parts need to be repaired or replaced. It can cost you anywhere from $1,000 to $3,000 just to replace your transmission! So the first fund you want to have is at least $1,000 in a transportation emergency fund! If you get super lucky and your car insurance covers everything, then you can use the fund money to pay for a taxi to and from work while your car is in the shop.
One of the most common reasons why people have poor credit is because of unpaid medical bills that went to collections. Most people think that health insurance will cover the cost of medical emergencies that might arise and they take it easy on saving for medical needs, but the reality is that most health care plans will only begin to pay for medical bills after you’ve paid your part, which is called the deductible. Deductible amounts vary depending on the plan details, but they generally renew every year or whenever you enroll in a new plan. The higher your deductible is the more you need to have saved in your medical emergency fund. The lower your deductible is the lower your medical emergency fund can be. So, it’s very important for you to know the details of your health care plan and to be especially familiar with your deductible amount!
This is the most difficult one for people to prepare for because of two reasons: 1) nobody wants to imagine losing their job and 2) nobody knows exactly how long it would take to get a new job or how much to save in case they do lose their job. I would argue that those things don’t matter as much as getting started with the habit of saving a small amount from each check for a job loss fund. Unlike the transportation emergency fund and the medical emergency fund, this fund doesn’t have a clear and specific purpose because it’s a combination of purposes. Typically as a result of job loss, you might struggle to pay rent or mortgage on time as well as other bills. People are naturally inclined to do the immediate things needed to survive (literally) like buying food and drinking water, but the bills and rent, as important as they are, do not register in the brain as priorities when you’re in survival mode! That makes sense and I totally get it. But, it means that we have to trick ourselves into saving because our brain doesn’t see it as a need in the same way as nourishment.
People overspend on food and housing when money is coming in and times are good. This is such an easy place to cut back a bit by downsizing your living situation to be exactly the space you need and saving the difference in cost, and packing lunch each day and saving the difference in that job loss fund. People with very secure jobs tend to think that they don’t have to worry about this. But this is not really an issue of job security, because just a few months ago when the government shut down, hundreds of thousands of people were reporting to work every day without getting any pay. If your job loss fund is in place, that money can be used during a government shutdown, or during the time it takes you to find a new job if you ever get laid off. Most experts say 3-6 months’ worth of expenses is enough but the exact amount can vary based on job availability in your field and location.
BONUS – Investments losing value
This bonus emergency to be prepared for is related to the markets and economic cycles, especially since you might’ve seen some talks of a recession on the news. A recession could mean jobs are on the line, but also investments that have been doing well as the stock market has been going up steadily since 2009 could drop in value, which could scare many investors. Keeping your expectation of the value of your accounts at a number much lower than what you see when you log in, will help you mentally prepare if the stock market drops drastically and the media goes into a frenzy. The economic cycle functions in a way where you can expect to see a steady rise in the markets followed by big drops and dips that recover after a few years and continue to increase again. To make sure that you can stomach the drop you’ll see in your own investments, it’s a good rule of thumb to subtract your age from the number 110. The result of that tells you how much of your investment portfolio money should be allocated to stocks. The remainder should be in bonds. As 30 years old, that means that 80% (110-30=80) of all; my investments should be allocated to stocks and the other 20% should be in bonds, which are more secure and have less risk of volatility like stocks do. Whether or not the market takes a turn for the worse, it’s important to know how it can impact your investments and be prepared.