I write these for my Soapy and all the Soapys we have in our own lives. You can read part of Soapy’s briefing here:
Soaps is one of my best friends. She is a remarkable person and a free-spirited, creative genius. My Soap is the daughter of a very affluent multi-millionaire family. Her childhood was what one would call pure opulence. Today, she is in her 30s with a drinking problem. She has terrible health and cannot hold down a job.
Read the previous posts in Soapy’s Odessey:
- 21 Frugal Pantry Staples List on a Limited Budget
- Practical Budgets For People Bad With Money
- How To Effectively Overcome Credit Card Addiction
- 3 Signs When Frugality Isn’t Worth It & What To Do
- Why The Rich Are Frugal Even When They Don’t Have To Be
Soapy recently addressed to me that her financial issues were no longer caused by overspending. That is good news!
“It’s not that I’m buying $12 bags of SunChips or cans of RedBulls. At the end of the month, I get most of my bills paid off. It’s the stuff that always comes up. Like last month, I lost my iPhone in the supermarket and had to replace it for work ASAP. Or a few months ago when I fell off the motor scooter and fractured my collarbones. I was gone for 2 weeks from work.”
The two weeks she was out of work, she had to hustle and borrow from friends in the remaining month to pay her rent on time. Her rent is $800 a month for a single room. Her living expenses are constant enough. She has no car and rides with friends. The loan repayment amount on her monthly debt is $700 and she owes a total of around $80,000.
I wrote back to her, “Your situation is basically what an emergency fund is for. Waaait…didn’t you ever make one?”
“Noooo I have a sh*t ton of debt.”
“You still NEED to build one, RIGHT now. Pay the minimum on your debts until you set up an emergency fund.”
“Because I can guarantee with your medical track record, something is going to go down before that $80,000 is paid off.”
What is an emergency fund?
An emergency fund is for life’s mishaps. It’s for medical emergencies, unexpected family obligations, employment loss, home and auto repairs, so on and so forth. Emergency funds are all cash and it sits in your bank as cash reserves.
In most cases, an emergency fund is not applicable for a “once in a lifetime road trip with friends” you haven’t seen in years. It’s invisible, untouchable money until a real emergency. Real emergency scenarios can include an unexpected rent hike or repairing your car so you can get to work.
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Why do you need an emergency fund?
1) It’s a step in the right direction.
It’s a mental thing. The more cash reserves the stronger the financial safety net becomes. If you don’t have an emergency fund then you are at the mercy of life. There are a lot of setbacks possible when you are as exposed as you are. Most people hate being controlled so think of the emergency fund as a mini “F-U” money. You get a little taste of what it means to be free from the perils of always having no money.
2) Avoid worst debts
Avoid adding more charges onto your credit card, tapping into retirement accounts (tax penalties) and borrowing money from family/friends.
You did most of these during your plights of apathy Soap. If you had a retirement account, you would be in even deeper trouble with the taxman and they won’t notify you until it’s due. That should be argument enough for an emergency fund, debt or no debt. Your emergency fund will prevent you from taking out other forms of debt that are much worst.
3) “My debts have X% interest though!”
Don’t dollar and dime for your livelihood when you’re this close to the edge Soapy. This is not the time to be haggling with your money.
If something does come up, I guarantee you will be thankful that I told you to build an emergency fund. The emergency fund can give you some form of security.
Remember how miserable and helpless you felt when you were just laying in bed for 2 weeks? It would have been better for your depression if you didn’t have to wonder about having a place to live after the month is up.
The best part of financial health is being able to feel safe and confident in a worth full of mishaps. When stress levels are down, you will bounce back with less anguish.
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How much should be in the emergency fund?
Reasonably speaking, an emergency fund should cover your basic expenses for 3 months.
Soap – “Bish I can’t get through the month and you want a 3-month emergency fund from me?”
(Real friends get to use the B word without ramifications, just sayin’.)
That’s a personal thing usually but Hubby and I try to keep a 3-to-6 month reserve in cash at all times. That’s why we were slowly converting into treasury bonds, so the cash could pace with inflation.
Everybody has different expenses. Most of the time, I say a must-have emergency fund should be $1,000 to $2,500.
Soapy, your loan payments are $700 a month and your rent is $800 a month. I would say you should have $1,000 as the preliminary, first line of defense.
“Numbers. This is so confusing.”
Save up $1,000. Have it sit there in the bank, all cash and forget about it. If you touch it for anything stupid, I’ll kill you.
(Real friends get to threaten your life without ramifications, just sayin’.)
After you save up the first $1,000, go back to paying off your high-interest debt like nothing happened and that $1,000 never existed.
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How to estimate an emergency fund amount?
It doesn’t mean you stop saving after building the first line of defense emergency fund. Continue living like you’re…um, me… extreme frugality woo.
In other words, that $1,000 is more like the first line of defense emergency fund. The official emergency fund comes with at least 3 months of expenses intact. Pour earnings into paying back all debts and loans but reserve some extra money at the end of the month until you have a 3-month emergency fund. Calculate an emergency fund by tallying up critical monthly expenses like housing, food, transportation, debt payment, and utilities.
In Soap’s case, she needs $2,800 to get by per month unscathed for housing, food, transportation, debt, and utilities. A 3-month buffer would then be $2,800 x 3 = $8,400 for her real emergency fund.
If another person has $10,000 worth of high-interest debt but can knock it off in a few months, I could just say hurry up and kill it after the first line of defense is up.
But Soapy has a high debt load at $80,000 and a ‘not so stable job’ so that’s my advice for her situation. Her mother cosigned for her and now her debts are consolidated to under 9%. I am projecting a 3 year pay-off period on the current timeline before she will have a positive net worth.
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Everybody needs an emergency fund,including Soapy! S**t happens! It’s even more critical if you have kids.
Haha agreed, she has two dog-kids.
Oh wow. Your friend is lucky to have you. This is great advice, too. Because something always comes up, and then if you don’t have $$$ you get caught up in the “paying off the credit card balance” game.
And she has enough experience with that game. I don’t think she read this post…she may have forgotten after I told her :l
Dave @ Married with Money says
An emergency fund is pretty much the most important thing to preventing yourself from getting totally screwed. I think $1k is a bit light, personally, and would lean toward ~1 month living expenses at a minimum, but whatever people are comfortable with I guess.
I suggested $1500 to $2000 but I was afraid that’s too big of a number for a super newbie like Soap.
Damn Millennial says
Emergency funds are so important.
One issue I have noticed though. Is that those who are in heavy debt may find a reason to spend the emergency fund once it is saved.
Not for an emergency but for a random purchase. So make sure it is out of reach and in an account that is harder to access to avoid temptation.
I use death threats, seems to work. 😀
Ms. Frugal Asian Finance says
I totally agree. You need an emergency fund of at least 1 month expenses no matter what. Life happens!
Si si sister FAF.
I totally agree that an emergency fund is still required while in debt and 3 months is fair enough. The idea being to ensure you do not have to rely on high interest debt/loan to rescue you if things go south, further worsening your debt situation.
Mrs. Groovy says
You need an emergency fund especially when you’re in debt because that’s when you invite more trouble. You know — Murphy and his three cousins, broke, desperate, and stupid (according to Dave Ramsey). What you need depends on your expenses, how employable you are if you lose your job, and other factors. Six months would make me comfortable if I were working and renting, but I’d want an extra cushion if I owned property.
Ha! No I didn’t know of the cousins! Hilarious!!
Joe @ Retire by 40 says
Yeah, she needs at least $1,000. Probably better with $2,000. She probably doesn’t need more than that. Once she paid off the expensive debt, she could increase her EF to 3 months.
Good luck Soapy!
Great advice Joe!
Sean @ Frugal Money Man says
The Emergency Fund may be the most critical step to the entire financial game. It is literally the only thing protecting you from potentially going down hill when life hits you with inevitable crisis. The fund is designed to weather the storm, so that in turn you aren’t draining precious resources from other assets.
On a side note, we actually stopped funding our Roth IRA’s this month so that we can build our emergency fund back up. We have to do this because we had to pay for our wedding in full, so we had to use the emergency fund to do it. After we fill our emergency fund back up in about a month or 2, we will be back to maxing out our IRA’s before the year is done.
Ooh, how much is the budget for your wedding?! Congrats!!
Abigail @ipickuppennies says
We’ve been lucky enough to never need to dip into our emergency fund, being able to just use savings. That said, we didn’t have an EF while paying down debt. We could always pay rent since our income was unemployment and disability — meaning we wouldn’t suddenly be out a paycheck from a firing, broken bone or whatever. And thanks to multiple chronic ailments each, there were too many unexpected expenses. I realized that putting money into an EF would be pointless: We’d be putting it in only to take it out later that month, then put in more to replenish, then take it back out… It made more sense to just throw every spare cent we had at the card and use the cards for irregular/emergency expenses.
But few people were in our unique position. So I think almost everyone does need an emergency fund. I hope your friend takes you advice. Even if she only puts $10 away a month. Eventually it’ll add up.
Very interesting scenario Abigail. It actually sounds similar to Soapy’s scenario, the only thing is she can’t pay rent with a card so her emergency fund as long as it covers 1 month rent, that would be a lifesaver.
Everyone needs an emergency fund of some sort especially the ones who are in debt. $1K-$2K should be the minimum because you’ll never know when an emergency situation my come up.