An emergency fund can save our hides in an unexpected event. That safety cushion can be used in an emergency, or as an opportunity fund. But using the fund is only part of the equation. We also need to replenish it, or risk going into the future financially exposed.
When is it okay to use your emergency fund?
Sometimes unforeseen events happen that put a strain on our finances. For these situations, we can dip into our emergency savings to prevent us from having to borrow money from other sources, like bank loans and credit cards. Our savings are designed to protect against the struggles of life, designed to make our financial position stronger and safer.
In general, your emergency fund is there to help with the one-time expenses that creep up on you. A car accident not covered by insurance, a medical emergency, or unexpected travel. Anything sudden that causes you to deviate from your current financial plan can be covered by your emergency fund. But be careful that the expenses that come up are really one-time items, and that you aren’t dipping into your emergency fund for everyday purchases. If that’s the case, your expenses are creeping too high and you’re in danger of living beyond your means. And that is a very dangerous road to travel.
You also could dip into your emergency savings for once-in-a-lifetime investment opportunities, after appropriate due-diligence of course. You don’t want to chase too good to be true promises with your financial safety net.
What do you do after you’ve used your Emergency fund?
What’s next after you use your emergency fund? Whether it is to cover financial shortfalls from a real emergency, or simply taking advantage of an exceptional opportunity, that money has come from a loan. You have loaned yourself funding to cover an extraordinary item, but make no mistake, you are still in debt. The only difference is that instead of borrowing from a bank or other source, you have borrowed from your future.
If you do use your emergency fund, you need to treat it as you would any other debt, pay down aggressively until you are debt-free, or in this case, until your emergency fund has been restored.
In the few times I have needed to resort to using my emergency fund, I treat that loan as equivalent to one my bank would offer me. That means that I charge myself interest on the loan I made to myself. As I pay down that loan, I also pay “interest” into my emergency fund, meaning my fund is larger than it started, and I have an even larger safety net to cover future financial shortfalls.
Using your emergency fund is okay, especially in emergency situations. That is afterall why we put those extra dollars aside. But when we do use our emergency fund, we need to remember that we are loaning that money to ourselves. When we consider the use of our emergency fund as going into debt, we think twice about using the money. If our cause is truly just, and we need to use our safety net, thinking about it as a loan also ensures that we pay it back quickly. That way we return to a state of equilibrium, where we protect our financial stability from the unexpected future.