An emergency fund (or cash reserve fund) is important to your financial security. I would say paying off high-interest debt and building up an emergency fund are the foundation of your financial stability. This rings even more true during these unprecedented times. But, when should you tap into your emergency fund? What constitutes a financial emergency? I believe the list of actual financial emergencies is short. This would include unexpected life events such as losing your job, a large medical bill, an expensive auto repair, or a substantial home repair. So, what is NOT a financial emergency and how should you plan for those expenses? Here are some items that I would not consider financial emergencies:
Property Taxes. If you use an escrow account to pay for your property taxes, then you are funding your property tax payment every month. This is an easy way to ensure you aren’t surprised by your property tax bill. If, on the other hand, you don’t use an escrow account, then you should be prepared to pay for this expense every year by budgeting for it in your monthly housing expenses.
Most Home Maintenance Expenses. Owning a house means having home maintenance expenses. There are countless things that need to be fixed or maintained. It is important to have a line item in your spending plan for home maintenance expenses. You can use an average of your home maintenance expenses for the past three years to give you a ballpark estimate. You can then round that figure up to account for unexpected expenses. This will at least give you a baseline estimate, rather than having a $0 budget line item for expenses that will invariably come up.
Most Auto Expenses. Buying new tires is not a financial emergency! Your auto registration is also not a financial emergency. Just like with home maintenance, there should be a line item for auto maintenance expenses and auto registration. These expenses happen every year, so you should be prepared to pay for these when they happen.
Most Health Services. This one is similar to home and auto maintenance, but this one is for maintenance on yourself and your family! Every year, doctor, dentist, and eyecare expenses probably come up (some years more than others), so you should plan for them. This one is harder to estimate because these expenses are much more unpredictable. I always advise budgeting higher than anticipated to create a “buffer” in your budget. If you end up spending less, then great! But, if you end up spending more, then the financial shock won’t be as dramatic.
Tax Preparation. If you have someone prepare your taxes every year, then you should factor it into your spending plan. I advise people to take their annual cost for tax preparation, then divide it by 12 to give them a monthly amount for their budget.
Holiday Gifts. This is another spending category that happens every year that seems to catch people by surprise. Similar to tax preparation, I would take the total spending on holiday gifts then divide it by 12 to give you a monthly amount for your spending plan.
How can you plan for all of these expenses in a simple way? I’m glad you asked! I would use a separate checking or savings account (“Irregular Account”) for most of your non-monthly expenses. You can then use one account to save for your property taxes, estimated home maintenance expenses, auto maintenance expenses, auto registration, health services expenses, and tax preparation fees. When you have large expenses in any of those areas, you can pay for them directly out of your Irregular Account or “reimburse” your main checking account. You can also include holiday gifts in your Irregular Account. Alternatively, you can set up a separate savings account for holiday gifts, then transfer that money to your main checking account right before you start your holiday gift spending.
I hope this was helpful in learning why you don’t need an emergency fund for most financial “emergencies.”