Emergency Funds vs. Savings Accounts: Navigating the Grey Area
Chances are, if you’re reading this blog, you know about emergency funds and savings accounts. But do you know the differences between the two and when to use them?
Let’s start out by defining specific uses:
Emergency Fund: Usually consists of unplanned expenses, the ones that pop up with no warning such as unexpected bills, deaths, job loss, illness, unexpected life circumstances and appliance repairs/replacements. I hate to mention it again but since the recession is upon us it is imperative that you have at least 3-6 months saved as any combination of the above is likely to create the perfect storm in your financial life. You’ll be able to sleep easier at night knowing that should any or a combination of the above happen, you’ll be covered in the majority of cases.
Savings Account: This is typically where you save for a specific goal such as downpayment on a car or home, childcare expenses, appliances, furniture, educational expenses, investments and hobbies. Obviously, these are planned expenses and not haphazard emergencies. We typically save to meet a certain goal that has been planned for some time. This prevents us from spending money we don’t have through the use of credit cards and increases discipline once the stated goal has been achieved.
The Grey Area This is an area I found myself going back and forth on with my husband because many of these are debatable. We listed the following as being in the grey area: traffic tickets, car getting towed, unexpected tax bill, prolonged medical expenses, legal fees and debt reduction. I’m sure there are more so feel free to list yours in the comments. All of these are debatable which is why they are in the grey area. Still, it makes sense to address these issues before they happen and decide which account should be used to cover these expenses. None of these are planned, but they aren’t dire emergencies either.
Questions to ask your self:
- Which account would you use to pay the junk yard to get your car back?
- What about that unexpected tax bill with April 15th around the corner?
- Legal fees to defend that reckless driving charge?
What about debt reduction? Some believe you should use savings to knock down debt, others believe you can use your emergency fund while some believe in working to pay down debt. I struggle with using my emergency fund to pay down debt because when you know what hits the fan, my bills need to be paid and I would rather pay the minimum in a pinch than give up security. That said I think it wise to create a “when sh*t hits the fan fund” so you’ll be covered and not have to dip into your savings or emergency fund.
What are your grey areas?
Is the ‘grey area’ the ’sh*t hitting the fan’? I wonder whether some of those things could be emergencies, eg when the car gets towed and you rely on it for work, doesn’t it makes sense to dip into the ‘emergency’ fund to pay to get it out?
I guess I wonder… what’s the difference between an ‘emergency’ and ‘fan-slug sh*t’?
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Thats the thing, do you want to dip into the emergency fund or do you want to sacrifice some of your discretionary spending? Different people would handle the situation differently. I’d probably use my discretionary spending because its not a dire emergency but I dont want to deplete the emergency fund unless I absolutely have to..
First of all, I just have one set of money that I dip into for anything that isn’t a set monthly expense… even hobby purchases if the pool of money is large enough that the purchase doesn’t deplete it.
But in the set of rules you’ve put up there, I would say that instead of having a gray area, you should put debt reduction on the savings account side and all the rest of the gray area stuff on the emergency fund side. Then emergency fund stuff consists of things that may or may not happen (I mean, you can pretty much guarantee that ONE of those things will eventually happen, but each individual thing might never happen), and savings account stuff is stuff that you know you are going to have to pay. If you have debt, you know you are going to have to pay towards debt reduction. If you want to take vacations, you know you are going to have to pay money towards saving for them.
Or alternately, you could just consider the emergency fund as the fist line of defense against unexpected bills, with the savings account being the second line of defense.
For me, the emergency fund is do not touch unless there’s some catastrophic event (i.e. job loss, serious illness, etc.). I have also general savings (not earmarked for anything in particular) that would be used for large unexpected expenses (like heaven forbid, the roof blew off).
Smaller unexpected expenses (i.e. unexpected bills, small repairs) as well as investments/hobbies/whatever are taken care of out of normal cash flow. Large purchases (i.e. furniture, travel) are planned in advance and saved for.
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[...] from Girls Just Wanna Have Funds talks about the grey area between emergency funds and savings [...]
[...] Girls Just Wanna Have Funds: Emergency Funds vs. Savings Accounts: Navigating the Grey Area [...]
[...] Girls Just Wanna Have Funds: Emergency Funds vs. Savings Accounts: Navigating the Grey Area [...]
Seems to me that what you pay out of your Emergency fund is going to depend upon where you are in the process of fixing up your finances and getting out of debt. When I first started working diligently at getting out of debt for good, my emergency fund ($1000) was for anything that I couldn’t afford to save money for (because I had so many little niggling debts to pay off): so car repairs, illness, unexpected bills, etc…
Once I paid off several of the smaller debts and freed up some monthly cash, I was able to reallocate some money to saving for expected annual expenses. In my mind, appliance replacement/repair, legal fees, debt reduction, unexpectedly-large tax bills and the like are not emergencies: you know that most of these things are going to happen at some point, so putting some money away into savings every month is a way of planning for them.
I have never had to dip into my emergency fund (touch wood!) but my general rule of thumb is that I will only pull from that if I’ve squeezed every penny from my budget, used the all the cash in my normal savings account and I *still* need more money in order to meet some unexpected expense.
What I’m a bit puzzled for is why debt reduction is considered “saving” at all? I pay as much as I can each month towards my debts out of my normal day-to-day budget. That money never sees either savings account.
The bottom line is that you have to live off of less than you make. Let’s not make Cadillac the number one dealer in America with our foolish spending. It takes persistence and consistency to save and increase your wealth…
My spouse and I just had this dicussion over lunch. We agree that the emergency fund needs to be large enough to cover all our bills for at least 3 months. Getting there will not be easy. All our savings are being used to attack our credit card debt. We have been paying off the smaller amounts and then using the extra funds to payoff the next credit card. It is working but it is slow and steady.
Great Blog! It’s my first time visiting. I agree there’s a difference between a savings and an emergency fund. I need to work on my emergency fund!
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[...] Emergency Funds vs. Savings Accounts [Ginger @ Girls Just Wanna Have Funds] Ever wonder about that “gray” area? When should I really use my emergency fund and what I should be saving for anyway? Hey – as long as you’re not incurring debt, it’s all good. [...]
Thanks, that must have taken a loads of work to put that together. This is a great summary.
Thanks, that must have taken a loads of work to put that together. This is a great summary.