We've talked about the power of the emergency fund but I'd like to go into more detail as to how to keep it constantly available in the event of emergencies, to care for unexpected expenses.
When there's an emergency, two things happen right away. First, the body goes into fight or flight mode, which is terrible for blood pressure. Second, the brain semi-shuts down and isn't able to process complex information. That's why having a solid budget with an emergency fund is so important: It buys you time. You can make that payment that's overdue. You can buy those groceries. You can buy that sports uniform for your child. You can save that credit score by making that late payment. Otherwise, you're just running in circles, always scrambling.
The general rule here is to put away $1,000USD to be used for emergencies only. And after you dip into it, the first thing you do is fill it up again.
When filling up the emergency fund, I find it's always a good time to look at the current budget. To understand that some bill came in that was unexpected and put things in the red, and that being reactive with money embraces the mindset of the poor. It's better for wealth generation, and maintaining a healthy, money mindset to manage your budget proactively. So here's what you do:
Start by identifying the last item(s) you spent your emergency fund on. Determine why this was an emergency. And come up with three solutions that would prevent the need of dipping into the emergency fund in the future, so you can assure this never happens again.
Let's say for example that you had emergency car repairs, and had to access the emergency fund to pay for part of it, as you had money set aside for basic car maintenance like oil changes and spark plug replacements, but you were honestly counting on your drive train lasting for at least another 50,000 miles. But, you hit a bump on the road that was undergoing construction and something did irreparable damage, and now you have to pay $850 to have it replaced. Leaving $150 in the emergency fund after all things were said and done.
Then you remembered that you have your mother-in-law coming next week, at the start of the month, and you didn't put aside money for her food expenses. And so that's going to eat up the remaining $150 in the fund. To exacerbate things more, you are told by the car repair shop that you will need to replace your tires by the winter as these were nearly bald and would be very dangerous to drive with the current tires as the snow arrives. But nothing had been put aside for any of these expenses and when you are told by your mother-in-law that she's going to be staying for three months, you panic. And have to come up with a quick solution.
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While this gives you the fuel to reach the finish line, providing you with some initial breathing room, it's best to start working on filling up that emergency fund again, and perhaps consider putting additional budget money into car repairs, and if you have any cash in funds left over at the end of the year, you can just redistribute it as you see fit. Priorities change. This accounts for it.
Remember, you are trying to have a little more than expected set aside for each line item, so that you are left with more decision-making power come moments like these when it seems expenses are hitting from all angles.
This comes from assessing what you are spending your money on, and what areas have surpluses, and you shift the money over. This will become easy and fun with time. And it will develop a mindset that comes with responsible money management.