Ah, the emergency fund. That cushion of cash you’re so glad to have when your company announces it’s downsizing staff, or when your plumber tells you that the water stain on the ceiling is coming from a giant leak behind the walls.
These unexpected life “surprises” are the reason we at LearnVest advocate having one month of your take-home pay in a rainy day fund before tackling any other financial goals—including big ones like paying off a credit card.
Even better? Working your way up to six months of take-home pay—or nine months’ worth, if you’re self-employed.
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But even if you’re hovering closer to the one-month-of-pay mark, consider yourself ahead of the pack: A 2015 Bankrate Money Pulse poll found that only 38% of respondents had enough savings to be able to cover even a small disaster, like an E.R. visit or a car repair.
And once you’ve joined the ranks of those who’ve reached their emergency savings fund goal, you hope, of course, that everything remains peachy enough to leave that rainy day stash untouched.
But if a disaster actually does happen, how do you go about, well, touching it?
According to financial pros, it all depends on the cost of your mishap and the size of your emergency savings.
For added insight, we asked LearnVest Financial Planner Matt Shapiro, CFP®, to assess three common hypothetical “I need to tap my emergency fund” scenarios and offer advice for how to draw down from a rainy day fund wisely.
Scenario #1: The Sputtering Transmission
Nick, 25, earns $41,000 a year as a computer help desk technician. After two years on the job, he’s managed to build an emergency fund of $2,500, which is about a month of his take-home pay.
He wants to keep growing his cushion, but his 10-year-old coupe gets in the way. The car needs a rebuilt transmission—a $2,800 job that his mechanic says should buy the vehicle another few years.
Nick could pay for it by tapping his entire emergency fund and siphoning an additional $300 from his checking account—which would mean cutting back on some happy hours and takeout for the month.
But he has a good credit rating, which has kept the annual percentage rate (APR) on his credit card low, so he could also charge all or some of the $2,800, paying the balance off over several months.
What the Planner Says: First and foremost, Nick should avoid using a credit card to finance the transmission repair.
“If it took him two years to save $2,500, it’s going to be hard for him to pay off a credit card balance of $2,800, with an APR of something like 10%—which will amount to a few hundred dollars in interest,” Shapiro says.
So Shapiro’s preference would be for Nick to tap his entire $2,500 emergency fund, and squeeze the $300 from his current budget—and then work on rebuilding the fund as soon as possible.
“I’d really like to see him cut back on flexible expenses, or work some overtime to build it more quickly [than over two years],” Shapiro says. “I’d suggest he aim for putting away at least 8% of his income.” That would work to replenish his emergency fund in about a year.
Another option? If his car may need more repairs in the future, Nick could consider buying a used car for about the same amount it would cost to fix his coupe now.
“If he can trade in his current car, and get a new one for $2,000 or so, that might be a solution,” Shapiro says. “Twenty-eight hundred dollars seems really expensive to fix an old transmission.”
Scenario #2: The Fallen Oak
Meeting planners Andrea and Bruce, both 33, have a combined annual income of $120,000. They earn roughly the same amount, and are diligent about funneling $500 each month into their emergency fund.
As of today, they’ve managed to sock away six months’ worth of one of their paychecks, for a total of $19,500—a cushion that helps give them peace of mind.
Unfortunately, an accident involving a rotting tree on their property has them stressing out: Two huge branches fell onto their garage, collapsing the roof and damaging the structure. Since they neglected to take care of the sickly tree, their homeowners insurance won’t pay for the repairs.
And there’s more bad news: All of the general contractors they’ve contacted have said that, in addition to removing the branches, they’ll need to rebuild the garage—with the lowest estimate coming in at $18,000.
The couple’s emergency fund would cover the total, but they feel uneasy about nearly depleting their account.
That said, they believe that they can cut about $1,500 from their disposable income for a while to either put toward the contractor bill or rebuild their emergency fund—although they aren’t sure how long they can maintain that level of belt-tightening.
What the Planner Says: Shapiro isn’t as quick to recommend that Andrea and Bruce sap their savings right off the bat, seeing as having a safety net is important to them.
In order to help them maintain at least some of their emergency cushion, Shapiro suggests that the couple consider applying for a home equity line of credit (HELOC), especially as interest rates are still relatively low. While financing a repair normally wouldn’t be preferable, Shapiro believes that Andrea and Bruce’s diligence with saving would enable them to pay off any credit they use quickly.
To pay off the HELOC, Shapiro says, they could take their $2,000 a month—the $500 they’ve been putting into their emergency fund, plus the $1,500 they can squeeze from their budget—and put that toward the borrowed money.
In theory, this could help them pay off $20,000 in less than a year, leaving their emergency fund untouched.
But if freeing up $1,500 a month from their budget will be too difficult to maintain, another option could be to split the cost of the repair between the HELOC and their emergency fund.
For instance, they may find that cutting $700 a month feels more reasonable, and choose to use their savings to make up for the deficit.
However Andrea and Bruce choose to divvy up the repair bill, a key consideration, Shapiro says, is that they borrow only what they can pay off in one to two years—any longer than that and they’ll be paying too much in interest.
“After two or three months of being unemployed, it’s time to get realistic. Often, the higher your salary, the longer it takes to get a new job.”
Scenario #3: The Pink Slip
Susan and Ben, both in their mid-forties, have built up an emergency fund equaling nine months of Ben’s take-home pay—or about $54,000.
As vice president at a menswear manufacturer, Ben makes $110,000, while Susan brings home $105,000 as a technology sales rep.
But a round of layoffs eliminates Ben’s job, and because of his short tenure at the company, his severance is minimal.
Before the job loss, the couple were using Ben’s salary to pay for such fixed costs as their mortgage and cars and their daughter’s private-school tuition. Susan’s paycheck went toward groceries, dining out, clothing, entertainment and other flexible expenses.
With their income reduced by more than half, they aren’t sure how to begin tapping their emergency fund. Should they see how long they can go without touching it? Or is better to start dipping into it now, with the hope that Ben will find a new job quickly?
What the Planner Says: Because Ben’s job loss directly impacts their ability to pay for the essentials, tapping into the emergency fund right away to cover fixed expenses makes sense. It’s a “that’s what it’s for” situation, Shapiro says.
But Ben needs to take a look at his industry’s hiring landscape fast and assess the likelihood that he’ll snag another job that pays equally well. Positions at his pay level may be hard to come by quickly—and if that’s the case, belt tightening may be in order.
“After two or three months of being unemployed, it’s time to get realistic,” Shapiro says. “Often, the higher your salary, the longer it takes to get a new job. And people with their kind of money have probably been enjoying expensive dinners out.”
If Ben is staring down the barrel of a pay cut, it’s time for the couple to start rethinking their lifestyle. Perhaps they can cut some flexible expenses and redistribute those savings to fixed bills, or nix a few monthly services they no longer really need. Those moves could help their income—and their emergency fund—go further.
The good news is that having a hefty nine-month savings cushion means they aren’t in dire straits. “If they can cut just $1,000 from their monthly expenses, that fund could last them almost a year,” Shapiro says.
Certified Financial Planner Board of Standards Inc. owns the certification marks CFP®, CERTIFIED FINANCIAL PLANNER™, CFP® (with plaque design) and CFP® (with flame design) in the U.S., which it awards to individuals who successfully complete CFP Board’s initial and ongoing certification requirements.
LearnVest Planning Services is a registered investment adviser and subsidiary of LearnVest, Inc., that provides financial plans for its clients. LearnVest, Inc., is wholly owned by NM Planning, LLC, a subsidiary of The Northwestern Mutual Life Insurance Company. Information shown is for illustrative purposes only and is not intended as investment, legal or tax planning advice. Please consult a financial adviser, attorney or tax specialist for advice specific to your financial situation. LearnVest Planning Services and any third parties listed, linked to or otherwise appearing in this message are separate and unaffiliated and are not responsible for each other’s products, services or policies.