When it rains, it pours: an “emergency fund appreciation” post

We knew August would be a financially intense month in the Fortuna household, but we were ready for it… or so we thought.

First, there was a full year’s property taxes. (Fun fact: even when your house is paid off and you’re mortgage-free, you still have to pay those. Our mortgage company used to collect property taxes and homeowner’s insurance gradually all year in an escrow account and pay the bills for us, so we never really thought about it. Now, we act as our own escrow and set aside 1/12 of the expected bills every month in a sinking fund.) So we had it covered.

Next, vehicle #1’s inspection and registration… NBD, we’d saved for it.

Vehicle #2 was down to 2/32 tread depth, so it definitely needed new tires, and it was due for its 60,000 mile servicing (to the tune of $500). But it’s cool! We had a sinking fund for all that too!

Then, we had an unanticipated car repair.

Then, we had unexpected medical expenses. (Mr. Fortuna threw his back out lifting in our garage gym.)

And then… our air conditioning stopped working. In August. In North Carolina.

This was officially A Situation.

Depending on who you ask, there are a few options when these things happen: opt for payment plans or financing, float the expenses on credit cards, open or use a line of credit, take out a 401(k) loan, or borrow money from someone you know.

In our case, we decided to go for an official first: we finally used our emergency fund!

Edited to add: I know some family and friends might read this and feel concerned. Please don’t be! We are still doing really well by every reasonable standard!

The reason we’re sharing this story is that even if you are doing really well, even if you have no debt and a strong income and a budget that includes sinking funds, and robust retirement savings and a taxable brokerage account and lots of confidence, you still might find that a given month presents you with an unexpected expense (or three) that’s simply more than you can cash-flow.

A fully funded emergency fund of at least six months of expenses, just sitting there in boring savings earning its “high yield” of (currently) 1.7% interest, sounds really boring, and maybe even dumb. (Hello inflation, my old friend… you’re higher than my interest rate again…) You might even be tempted to keep way less money in your emergency fund, and cap it at two or three months of expenses. But having at least six months of expenses in this boring ol’ fund means you don’t have to float several thousand dollars on a credit card and pay interest. You don’t have to withdraw money from a retirement or brokerage account and deal with taxes/penalties/realized losses, and you don’t have to take on new debt. Those things wouldn’t be the end of the world, but why not avoid it if you can?

And maybe something that happens is a little more world-jarring. Maybe you get laid off, or need to leave your job for your health/safety/sanity, or to care for someone you love who needs you. I don’t know about you, but I want as much breathing room as possible to delay feeling any financial stress while I’m under emotional stress.

All this to say: we don’t ever WANT to have to use our emergency fund… but that’s what it’s there for, and we are REALLY glad we have one.

Our emergency fund is nothing fancy: just a high yield savings account that (normally) contains about six months of living expenses. Because we had that money saved in plain old cash, we were able to pay for these costs up front without incurring any taxes or penalties, or realizing any market losses. There were no bankers, no credit checks, and no awkward phone calls… just a few clicks.

This month, our emergency fund saved us from defaulting to one of many options that would have increased overall costs to us and added more stress to our lives. If you aren’t yet on Team Emergency Fund (c’mon, join us! we have snacks!), let’s talk about the downsides of other options that might be floating around in your mind as a backup plan. In no particular order, here are some things that are less awesome than a fully-funded emergency fund:

Floating emergency expenses on credit cards

This is pretty easy to consider as an option. But if you’re in the habit of paying off your card every month (which we do), the terms and conditions might not have fully registered for you. For example, I never really think about the fact that my card charges a variable purchase APR… which is currently 16.24%, and if I whiff on my payment, my APR can go up to the max of 29.99%. BIG YIKES. (Also, lenders don’t have to include fees in the APR that they tell you — so it can effectively be more. Your APR may be variable instead of fixed, and you can be charged different interest rates based on the type of money you’re using — purchases, cash advances, balance transfers.)

If you’re not super familiar with how credit card interest works, the APR stands for Annual Percentage Rate — the yearly rate charged for borrowing money. The APR reflects the cost of borrowing money over the course of a full year, but your interest compounds every single day.

Your monthly APR is your APR➗12, and your daily APR is your APR➗365. On its own, that might not seem too bad. You think, “Oh, I’ll just catch up next month when things calm down.” But that interest adds up fast. If things don’t calm down, you can wind up paying interest and fees that quickly add fuel to an already stressful fire.

Choosing payment plans or financing

If you opt for payment plans or financing directly from the company that you’re working with, you don’t have the advantage. You’re not getting to comparison-shop, and if you’re subject to high-pressure sales tactics, you may not even get to thoroughly read through the (often misleading and confusing) fine print.

Some payment plans or financing are 0% interest for a period of time, but in our experience, even a really straightforward no-interest payment plan (like the one we faced with our recent medical expenses) tends to cost more than a lump sum option. Many businesses would vastly prefer you hand them a large pile of money now rather than taking the chance that you’ll back out later, and they create incentives accordingly. Being able to pay up front saved us ten percent!

Using a personal loan or line of credit

For most of these, one of the BIGGEST downsides is that, whoever the lender may be, they know you’re in a pinch. This can come through in vaguely exploitative lending practices and fees. There are even-worse, highly-predatory loan products like title loans or payday loans, and they specifically look to take advantage of people facing desperate circumstances who feel like they have no other options.

Emergency fund = loan shark repellent.

Personal loans have interest rates that vary wildly (could be 3%, could be 36%). They are hugely dependent on your credit score, income, and existing debt. In other words, lenders only give you a good deal if you are already in pretty good shape financially, and if that’s the case, you’re also probably more equipped to manage an emergency. HELOCs, or home equity lines of credit, can seem like a better deal than credit cards because their interest rates tend to be lower, but they’re tricky for the same reasons… with the added downside of entangling your house. Ditto for auto equity loans, which are like a HELOC on your car.

Even with a low-interest, low-fee product from a reputable institution, it’s worth noting that anytime you formally borrow money, it can affect your credit score — both the inquiry and the amount borrowed. And that’s before any late or missed payments, which might happen, because when it rains… it pours.

Taking out a 401(k) loan or withdrawing from your Roth IRA

Although borrowing from your retirement account seems easy — it’s already your money! you pay the interest to yourself! — this can be as costly as a high-interest loan, after quirky tax consequences that can quickly erode the progress you’ve made on retirement saving. Worst of all, if you wind up unable to pay back your loan or lose your job, the loan converts to a “withdrawal” and comes with taxes and 10% penalties. (The 401(k) loan is described by Investopedia as the “nuclear option.”)

Technically you can’t “borrow” from your Roth IRA, but you can take a withdrawal. If you limit it to “contributions only,” there’s no penalty, but you’re suffering the opportunity cost of what that money can earn you. If you withdraw the earnings, you can face a 10% penalty if the withdrawal is not paid back within 60 days (which sounds a lot like borrowing), or if it’s not a qualified expense (this is a fairly short list involving permanent disability, high medical expenses, $10k or less for purchase of a “first” home, or unpaid taxes — but only if the IRS takes them out directly). Again, that’s an expensive way to get the money you need.

If you like the idea of borrowing money from yourself, but you’re not into tax punishments… enter the emergency fund! You get all the perks of borrowing money from yourself without worrying about the penalty-and-tax man, and you can “pay yourself back” on your timeline.

Borrowing from family or friends

This one is just a tough one. If you’re in a bind, people who care about you will often want to help you out. But if at all possible, try to avoid “lending” to or “borrowing” from friends and family. Getting into a borrower-lender relationship with someone you care about can add a dynamic that’s stressful for everyone; for instance, the borrower may feel discomfort or shame until the favor is repaid, or the lender might find themselves frustrated with the borrower’s other financial choices and priorities.

“This is a lovely bottle of wine, sweetie. But you really shouldn’t have, especially since you still haven’t paid us back. Cheers!”

This doesn’t mean we don’t want people to help each other out in times of need — FAR FROM IT. If someone wants to give you money with no expectation of you returning it, or if you want to do the same for them, that’s amazing. We LOVE generosity. But it can be awkward at best and relationship-ruining at worst when strings are attached, so we recommend avoiding this… more for emotional reasons than financial ones.

Essential caveats!

Let’s be crystal-clear: no part of this is intended to shame anyone who finds themselves in an emergency without a cash cushion to fall back on. This really isn’t aimed at you — and if that’s you, please reach out. We would love to help you identify the least risky options for your situation! And also, know you are not alone: there are many, many people who choose one or more of the above because they believe that they have no other way out. Entire industries are built on this truth.

Being in a position to build an emergency fund is, actually, a sign that things are going pretty well. So let’s say you’ve found a little extra financial breathing room (no small feat, these days) and you haven’t yet deliberately created an emergency fund. Why not prioritize dedicating your “extra” to take care of your future self? Maybe you’ve got a bonus coming. Maybe the student loan relief programs are going to really help you out. Maybe you make a small change that saves you a few bucks a month. Every little bit can help, even if it just helps you borrow less money in an emergency.

That’s me. Where do I start?

Our general recommendations are to first save up $1000 or a single paycheck (whichever is less). That $1000 is there to keep you from borrowing more while you work on paying down non-mortgage debt, which will help free up the parts of your monthly income that are currently going towards payments — but if you’re facing A (possible) Situation, it may make sense to save up a little more before you tackle debt paydown.

Your emergency fund should be saved in a dedicated savings or money market account, not mixed in with other money, and not saved in a vehicle that would penalize you for early withdrawals (e.g., a CD). Your emergency fund shouldn’t be invested in the markets, either, because volatility is not something you want in your backup plan.

For more details on how we view and set up the emergency fund, check out our post here.

Attentive readers will also notice that I described a certain hypothetical emergency in that post…

Did I bring this on us? Is it me? Am I the drama??

If you’re on board with the idea of creating an emergency fund but not sure how to start, I’d be delighted to sit down with you and help you figure out what your fund should look like, and help you find the “extra” that can get it going — grab your complimentary Financial Strategy Session here!

Photo credits: Tatjana Zmushko, Pixabay, GEORGE DESIPRIS, Julia M Cameron on Pexels.com

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