There are a lot of unexpected events that happen in our lives. Yet, we should expect the unexpected.
Here’s how I think most of us live:
We stand at the edge of a financial cliff. The slightest breeze, push, or shake will cause us to topple down the cliff. The breeze could be an unexpected emergency expense like a broken appliance or medical procedure. The push could come from a job loss or pay cut. Regardless of where it comes from, most of us are a financial house of cards that are on the verge of crumbling.
The way to expect the unexpected is to save up a specific amount of money, without knowing how that money will be used, to pay for the unexpected event.
You could call this several things:
- An emergency fund
- A buffer
Either way, there needs to be something that helps you step away from the cliff.
This way if a breeze, push, or shake comes, you’ll be pushed closer to the cliff, but you’ve still got several feet to get back on your feet before you’re on the verge of the dangerous drop off.
As an example, last year I had surgery to remove skin cancer. The total cost was about $3,000 out of pocket. When I set my 2012 goals, I didn’t make a plan to have skin cancer, but my light Scottish skin didn’t bode well with the hot equatorial sun of Papua New Guinea. Now, let me be clear that it is no fun paying $3,000 for any medical procedure. I could probably think of 1,000 ways I’d rather spend the money, but I can say that it wasn’t a financially stressful situation because we maintain a buffer account with funds to help provide in unexpected times.
When we budget, we plan for expected events and expenses that we know are coming. When we put money in a buffer account, we save for events that are unexpected.
Best Way to Be Prepared to Expect the Unexpected
- Set a clear target – I’ve heard recommendations that you should save anywhere from 3 – 12 months worth of expenses (not income). The amount probably depends on the predictability of your job, your industry, the stability of your home, and your personality. We aim for about 5 – 6 months worth of living expenses. Since I’m self employed, I also keep a business emergency fund. Be sure you have a target of $xyz for your account.
- Be disciplined – Realize that building up an extra buffer fund will take time. It takes self sacrifice to give up what you want now for an unknown expense in the future. However, the only way to do it is with discipline and forward thinking.
- Set up a separate account – The best motivator for reaching your goal is to see the progress in a separate account. I bank with ING Direct (which is now owned by Capital One), and I just opened up a new sub-account for our emergency fund.
- Only access the account in a true emergency – If you know that you’re getting a bill next month, that money shouldn’t come out of this fund. These funds should only be used, whenever possible, to cover unexpected expenses.
- Rebuild it, if and when, depleted – When you use funds from the emergency fund, take time to build it back up.
How does this account help others?
Many of us make financial commitments to organizations. That may be our church or another charitable organization. Clearly, if we come upon financial hardship, we’ll struggle to keep those commitments unless, as part of our financial plan, we’re prepared for down times. This is why the first part of our priority in giving is to our family.
Howard Dayton talks about it like ships in a harbor. When the tide rises, all the boats are impacted. When you are financially healthy and stable, you’re in a position to help the tide around you to rise.