April 11, 2016

News You Can Use: Saving for a Rainy Day

Since our Biblical Financial Principles this month center on saving, we thought we’d dive a little deeper into a key element of saving – Emergency Saving – by looking at some frequently asked questions we receive. We hope you’ll find these questions and answers helpful.

What is Emergency Saving?

Emergency Saving encompasses money we put aside to handle unexpected events or crises, such as an unanticipated car repair or replacement of a failed appliance.

Why is Emergency Saving important?

Crises and unexpected expenses will occur in our lives – it’s not a matter of if, but a matter of when and how much they will cost. Preparing for these situations with emergency savings is the first and best defense against going into debt in response to an unanticipated crunch.

Why not just use a credit card if a crisis occurs and then pay it off?

Chances are, if you’re not putting money aside for savings in your budget today, then you’re already maxing out your income with expenses. If a crisis occurs and you use a credit card to handle it, where will the money come from to pay off the credit card? If you can think of where you’d adjust your budget in response to a crisis, then make that change today and put the money aside first, so you can avoid the interest associated with credit cards.

What constitutes an Emergency?

People define this differently, but for our purposes an emergency is an unforeseen need that requires a non-trivial amount of money to address. So, for example, Christmas shopping is not an emergency! Though it might qualify as a need to some extent depending on your family, Christmas is one of the more predictable events in our lives. Similarly, an unexpected chance to go to an expensive event is not an emergency. While you might not have anticipated it, the event is typically a want rather than a need.

How much money should I have in Emergency Savings?

Opinions on this vary, and to some extent it depends on your risk tolerance and your willingness to do without some things you have considered necessities. (For example, you could probably wash dishes by hand if your dishwasher broke.) A good place to start is to have at least $1,000 in your Emergency Savings fund. This is enough to replace most appliances if they break and it’s enough for most car repairs (though not all).

Once you’ve achieved the minimum, consider shooting for 3-6 months of expenses in your Emergency Savings fund. Note that this isn’t 3-6 months of income (hopefully your expenses are lower than your income!). This is enough to cover for the possibility of losing the ability to earn income for a limited period, whether through loss of a job, an accident, etc. If you were unable to work for 3-6 months, what bills would you need to cover? Your insurance might cover your medical bills, but consider housing, utilities, transportation (possibly a reduced need), food, etc. Also take into account the payments on any debt you may have (loans, credit cards, etc.).

What form should my Emergency Savings fund take?

Emergency savings should be in a form that is very liquid and that entails next to no risk. The point of emergency savings is not to earn income – think of it as more of an insurance policy. So you’re not concerned about interest rates, dividends, or appreciation in value. You’re concerned about stability and liquidity. Generally, a savings account or other very flexible instrument that allows you to withdraw whenever you need to without a penalty is a good vehicle for Emergency savings.

One last note…

Emergency savings is a form of self-insurance and can save you money in a couple of ways. First, if you have savings to cover a crisis, you won’t have to go into debt to resolve the issue, so you’ll be saving the interest on a credit card item or a loan.

Second, and more subtly, having Emergency savings can free you from the “protection plan syndrome”. Nearly every major appliance you buy these days – and many smaller items as well – comes with an option to buy some sort of protection plan. These plans vary in detail, but they typically promise to replace or repair an item at low or no cost should a problem arise. These plans can provide some peace of mind for the consumer, but they are huge money-makers for the sellers.

Suppose you’re buying 5 appliances and each one costs a bit under $1000. You could purchase a protection plan for each one and pay that extra money five times. Or, you could have an Emergency Savings fund that would allow you to replace one if it broke out of warranty. The likelihood of more than one of them breaking at the same time is pretty small, so you could actually protect all the appliances with the same money, rather than covering each one individually by paying extra for specific protection plans.

Emergencies will occur…The question is, will you be prepared?