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Updated on Tuesday, December 29, 2015
It’s common personal finance advice to build an emergency fund – an easy-to-access account with enough money to cover your expenses for three to six months. How to get started and where to keep the money might be up for debate. Some people may even go back and forth about what qualifies as an emergency. But, as the stories below demonstrate, the value of having an emergency fund is certain.
Hold Out and Get What You’re Owed
A user on Reddit shared an experience when an emergency fund led to a substantial financial gain. His wife lost her job, and the company owed her an undisclosed but large sum of money. The company offered her a payment worth 20 percent of the amount owed, but because the couple had a six-month emergency fund ready, they didn’t feel rushed to accept. Instead, they hired a lawyer, sued the company, and eventually got the full amount owed to them.
The wife also found a new, better job within two months and they only had to use about 20 percent of their emergency fund during the transition.
A commenter on this thread points out that similar situations can happen after auto accidents. The commenter says their ex was a claims adjuster and would push to close a case as quickly as possible. Once there’s a settlement the case won’t be reopened, even if you discover a new injury. Those that need the settlement money right away might agree to the rushed closing while those with an emergency fund can wait a little while to see if they discover new bodily pains or damage to their vehicle.
A Car Accident
A car can be an essential part of life, especially if you need one to get to work or school. Melanie Lockert, Founder of Dear Debt, says, “When I was living in LA and got in a car accident, I had an unexpected $1,800 repair bill. My emergency fund turned my expense into an annoyance rather than a crisis.”
Keeping accidents from becoming financial crises is one of the largest benefits of having an emergency fund.
Some emergency situations are more serious than others. A damaged car or a lost job can set you back, but the death of a loved one can be an emotional and financial blow. Jessica Garbarino, Founder of personal finance website Every Single Dollar, only had a small emergency fund while she was paying down debts. On New Year’s Eve, she got a call that her grandfather wasn’t doing well. Although the savings account wasn’t much money, her fund could cover the cost of a last-minute plane ticket from Florida to Minnesota, and she was able to spend a few precious days with her grandfather before he passed away.
A Little Bit of Everything
Another Redditor dealt with several emergencies back to back. Over a five-month period, he had a kidney stone removed, which set him back about $5,000, and was hit by a car, adding another estimated $1,200 to $1,500 to his tab. His car got backed into, a rock hit his windshield, he needed new brake pads, and he did some other general service to his car. In total, he’s estimating the cost came out to be around $10,000 including the lost wages from taking time off work. But, his emergency fund was beyond six months of expenses and he optimistically writes, “Having the cash on hand? Priceless.”
How to save while paying down debts
Unfortunately, emergencies do happen. But, as the four scenarios above exemplify, one of the most powerful things an emergency fund can give you are options. You can choose to travel at a moment’s notice, hold out for a fair and full settlement, or repair a vehicle right away – and get to do so without going into debt.
But, what if you’re in the process of paying down debt? How do you decide when it makes sense to put money towards your debt rather than contribute to an emergency fund?
One option is to start small and aim for building a $500 to $1,000 fund while making debt payments. You may only be able to put aside a little money each month, but those savings do add up and a small cash reserve can be enough to get you out of some sticky situations. You can also use a year-end bonus, tax refund, gift, or other influx of money to jump-start an emergency fund.
Grayson Bell, Founder of Debt Roundup, shares his method for paying off debt while building savings. He started by putting 95 percent of his disposable income to debt payments and 5 percent towards savings. After some time, he adjusted his allocation and put 80 percent towards debt and 20 percent towards savings. He suggests creating your own milestones that trigger change.
Some people will forgo an emergency fund, or saving of any kind, while paying off debt in the hope of getting back in the black quickly. For Grayson, one important reason to start saving was to change his mindset around money. Beginning to regularly save, rather than spend money on himself or his debts, was an important part of getting his finances in order.