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You know the drill—something breaks, wears out or costs more than you can cash flow. When that happens, where does the extra money come from? If you’re following Dave Ramsey’s seven Baby Steps, you have two options: dip into your emergency fund or start a savings fund.
Your emergency fund is the money you’ve saved for those unexpected costs that would otherwise blow your budget—like a midnight trip to the emergency room. Your savings fund is the money you’ve been socking away toward a future purchase, like an anniversary cruise to the Bahamas.
But not every situation is as clear-cut as medical bills and island getaways. How do you classify a true budgeting emergency when, let’s face it, it’s a gray area? It all boils down to three simple questions.
1. Is It Unexpected?
Life has a few surprises we could all live without. A job layoff is one of them. In that situation, you should use your emergency fund to keep the lights on and put food on the table until you land that next great job. Or if a tornado or flood hits your neighborhood, it’s perfectly fine to break into your rainy-day stash. Use it to cover insurance deductibles and other property damage your policy doesn’t cover—that’s what it’s there for.
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Annually recurring expenses, however, do not qualify as emergencies. To avoid being caught off-guard by back-to-school shopping and holiday gift-giving, save a little each month in a savings fund. Then you can relax and enjoy these big occasions—without touching your emergency fund.
2. Is It Necessary?
Necessities are often confused with wants, but the two are oceans apart. If your car breaks down and that’s the only way you can get to work, you need to get it fixed. Or if you discover a forest of mold growing behind your children’s bedroom walls, you need enough cash on hand to temporarily move out and pay for the cleanup. Those are emergencies!
On the other hand, if you’re tired of the kitchen countertops or want to upgrade to the latest and greatest cell phone, think again. As long as the kitchen is functional and your phone can call 911 in an emergency, upgrades aren’t necessary. New stuff is great, but don’t steal from your needs to pay for your wants.
3. Is It Urgent?
When an immediate need arises, the last thing you want to worry about is how you’re going to pay for it. So if your child catches a baseball with his face and needs stitches, or your furnace dies in the dead of winter, don’t stress. Focus on the task at hand and leave the rest up to your emergency fund.
Now, let’s say you have three hungry, growing kids and a dishwasher on the fritz. Replacing it isn’t urgent, but as soon as you know you only have a few months left to go, you should start putting money aside in a sinking fund. Then, when the dishwasher inevitably gives out, you have money to put toward a new one.
If You Have to Use the Money, It’s Okay!
Your emergency fund may feel like a ton of money just sitting there doing nothing, but it’s actually doing a lot. It’s your insurance policy against the unpredictable. So don’t drain it just because you see something shiny and new.
But keep in mind that you have permission to use your emergency fund if you have an unexpected, immediate expense. Just remember to replenish your savings as soon as you get back on your feet. You never know when you'll need it next.
Remember, savings is the margin between you and stress. Ready to start saving for emergencies and big purchases? The first step is to create a plan for your money—and that plan is called a budget! Sign up for our free budget app, EveryDollar, today!