Emergency Fund – Changing Your Behavior
We all know that we should have an emergency fund in place to help deal with unforeseen circumstances that happen in life. By being prepared ahead of time, we are better able to avoid taking on a large amount of unexpected debt. Yet, an emergency fund does more than prepare you for unforeseen circumstances; it also helps to change your behavior as well. When living paycheck-to-paycheck for an extended period of time, sometimes changing our behaviors/habits are just as important has having some money saved up in the bank. For example, when setting up an emergency fund, we tend to
Be Forward Thinking
In living paycheck to paycheck, we tend to be thinking just about how to make it through the end of each month. Our thinking is very short-term, specifically on what we can do to survive our financial struggle. It is a continual process of putting out fires where we have no energy to concentrate on the long-term that we need to get out of our situation.
With an emergency fund, our needs for the month are taken care of. Thus, we can start looking forward to the future. When our focus is on short-term survival, we stay stuck in the struggle because we can not see far enough out to avoid the financial pitfalls before they occur. When we look long-term, we can start avoiding issues before they become a fire that needs to be put out. We can see where the long-term issues are and start making adjustments accordingly. In management training, the discuss things we do each day that are graded on urgency and impact. We tend to spend a lot of our typical day on urgent things that are important (emergencies). However, to be effective, we need to plan ahead and spend more time in non-urgent activities that are important to avoid them becoming emergencies. Thus, the more we plan ahead the better off we are.
Be Understanding of Our Risks
One of the misconceptions of an emergency fund is that it should be a fixed number of months of living expenses (being 3 to 9 months depending on which financial advisor you are talking to). This general rule of thumb is meant to get people to put money away. Yet, to optimize your emergency fund, we need to better understand our risks. If we have higher risks (e.g., older, have medical plan with higher co-pays and deductibles, no disability insurance, etc.), we may want to have a significant emergency fund because we have a higher likelihood of needing it long-term. Thus, there is not a specific target that we should have because it is dependent on the risks we have.
By seeing what we need for an emergency based on our risks, we are better able to manage our behaviors day-to-day to reduce our overall risk. For example, if we work in a shrinking employment field (e.g., manufacturing), we may need to look out for other opportunities to keep our resume up to-date and find ways to expand our employment opportunities (through training and/or seeking out new job). Maybe we can to switch fields to become a car mechanic instead of building cars especially if we know the plant we work in may be shutting down in a few years.
There are risks with personal finance. However, when we are aware of our risks, we can better manage them by adapting our behaviors accordingly. Maybe we save more money when our job or our health is at risk. Maybe we increase our networking efforts, when we feel our job at risk. Whatever it is, the more we know about our risks and look forward to what may be a problem down the road, the better prepared we will be to deal with the situation.
Have Other Savings
I have seen situations where people have not been able to save money of any significance for most of the adult life (20 or more years). They have gotten into a pattern of spending everything that they have. For some, this may be tied to a belief in the phrase “easy come, easy go”. Their spending habits (anti-savings habits) may be due to anytime that they have had some money saved up, they have seen something happen (like a car breaking down, tax payment comes due, etc.) that has wiped out their savings. Thus, they subconsciously believe that they should spend the money before the next bill collector comes a calling. Their belief is that they should enjoy their money before someone else takes it first because someone else will take it if they do not spend it first.
A well funded emergency fund helps people get over the inertia of having savings. Just like an airplane spends more energy trying to take off the ground to overcome the initial inertia of gravity, so does it take some extra effort to save money at first when you are not use to saving. Yet, once you see that saving money is possible via an emergency fund, savings behavior can be carried forward to saving for retirement as well. If we only save up $500 to $2,500 (one to two months of living expenses), something is more likely to come up to wipe it out, proving our miss belief that we are unable to save. If we save up, an adequate emergency fund (6 to 9 months), then we can handle the little bumps in the road and retain our savings showing us that we can get ahead of the game with a little diligence and effort.
Be Empowered
Having an emergency fund is shifting from being a victim to being empowered. When there is no savings, it is hard to see all the choices that we have because we are just concentrating on paying the next bill. When something happens, we see very little that we can do about it because we are scrambling to find any way to pay the bills.
By having an emergency fund, we are in more control of what we can do when something unforeseen happens. We can see our choices because we have time to react to how we are going to pay the bill because we always have a fall back plan (using the emergency fund). The key thing is that when we feel that we have more control of a situation, we are able to see more opportunities. When we are able to see more opportunities, we can find alternative ways to pay for bills rather than being a victim to sales agents or payday loan firms.
For example, if our car all of a sudden breaks down and it can not be repaired, someone with no emergency fund will be more desperate and go out and take what ever offer is being provided. It is a recipe for being taken advantage of especially if the car dealership senses our desperation. Someone who had an adequate emergency may be in a similar position (a bit desperate for wheels). Yet, they have the option of renting a car for a week to look for a better deal especially if it means saving $1,000 or more off the price of the car by not being as desperate. Or, they are able to look around to find the perfect used car rather than taking the first car they see because they have no money to take off of work to look for a car that may save them $5,000 by shopping around.
We always think that money is the solution to all our financial problems. However, it is our behaviors that have more of a long-term impact on our financial situation. By moving forward to set up an emergency fund, we are not only putting aside money that we may need later but more importantly setting up better financial habits that will pay larger long-term dividends. Setting up an emergency fund is a step towards being empowered to save for retirement and a step towards being a better negotiator by having all our options at our disposal instead of making quick decisions because we are running around putting out fires.
