At one point in your life you will encounter a financial emergency. Now the word emergency could be defined in a number of different ways. An emergency to me is something that comes up suddenly that can lead to a great detriment to one’s life. For example, if your engine blows up in your car or if you lose your job suddenly those would be emergencies. In fact, there is a possibility that many of us will lose our jobs at one point or time in our careers. It is a rare occasion when someone will work for the same company for all of their professional lives. My dad was one of those people. However, even he suffered a job loss when the plant he worked at closed, he was laid off, and basically was forced to retire. Now in my dad’s case it wasn’t so bad. They gave him a fairly large severance, he took unemployment and by the time he was done with everything he was eligible for social security and decided to retire early.
That said emergencies, like a job loss, will often occur to many of us in our lives. Both Mrs. ROB and I both have experienced job losses in the past. The good thing today is that I have a pretty secure job and the likelihood of a layoff for me personally is unlikely. Mrs. ROB’s position is less secure. Thus, it is possible in the near future that we might lose her income, or at least part of it, for a number of reasons. If that is the case you can certainly argue we will experience an emergency.
Therefore, we will need an emergency fund. The biggest question what constitutes that emergency fund?
How Do You Determine Your Emergency Fund?
Typically, there is some pretty generic advice when it comes to emergency funds. Most financial professionals recommend 3-6 months of expenses depending on the security of your job or your assets. Some financial professionals, like Suze Orman, recommend 8 months or more of expenses because of the potential of a job loss.
The problem is that saving 3-6 months of expenses or 8 months of expenses can be daunting. Moreover, what kinds of expenses do you determine this amount to be? Is it all expenses like student loan payments? Housing expenses? Credit cards, etc? I mean it would seem to me if it was a true emergency that credit cards, student loans, and other ancillary expenses wouldn’t be part of the equation.
Use the “Four Walls” Metaphor to Construct Your Emergency Fund
When I think about creating an emergency fund I think of the most basic expenses or the “four walls”of expenses. I get the four walls metaphor from Dave Ramsey who talks about taking care of the four walls of your financial life before anything else. Those four walls are food, shelter and utilities, transportation, and basic clothing.
And if you think about it the four walls are what you would focus on most in a true emergency. I mean if you can’t pay your credit cards or student loans or something you might hurt your credit, but who cares. I mean you are experiencing an emergency. Everyone else isn’t important as feeding, sheltering, and clothing your family. So the four walls are really the true expenses you would focus on in an emergency.
There are also two advantages of the four walls emergency fund. First, the specific costs of what those expenses are fairly easy to calculate. Expenses like rent or mortgage, utilities, basic food, and transportation expenses (car payment, insurance, and/or gas) are pretty regular. Therefore, I can get a pretty accurate baseline without too much calculation. If I include other things like going out to eat, clothing, other debt payments, those can be more difficult to calculate and we would get rid of those expenses anyway. Secondly, using the four walls metaphor makes it a bit easier for us to save those expenses. For example, if your bare bone expenses are $2500 a month, but we spend $5000 a month on additional expenses (e.g. entertainment and the like) it is much easier to save $7500-$15000 than $15000 to $30,000 or more. One of the primary reasons people don’t save for emergencies is because it can be fairly daunting. I mean getting people to save for retirement is difficult enough let alone basic emergencies. So by focusing on the four walls it makes the saving process a little less daunting.
The Bottom Line: Most likely, it will rain financially in our lives someday. That could be because your car breaks down, you lose your job, unexpected medical expenses, and the like. An emergency fund is an umbrella. At the very least have an umbrella that will keep you somewhat dry. And then later you can get one of those golf umbrellas that will really impress others.