Step 3: Self-Insure Against Emergencies
“It’s only when the tide goes out that you learn who’s been swimming naked.” – Warren Buffet
Life is full of unexpected events and they can cost us a bunch of money. Funerals, home repairs, layoffs or job losses, auto accidents or mechanical repairs, medical bills – they all seem to come out of nowhere and grab us in a stranglehold.
When you live paycheck to paycheck, these sorts of emergencies can ruin your day in a hurry. Most of us are not prepared for financial emergencies, so when they happen we have to reach into the wallet for the credit card and go deeper into debt.
It doesn’t have to be that way. You can be prepared for such emergencies. All you have to do is set aside some money in a separate bank account and dedicate it for emergencies. It’s called an emergency fund, and it works wonders (when you let it work).
I know it’s daunting to think of saving a few hundred dollars, let alone a few thousand, when you’re short on money. But it’s really not that hard, once you stop digging deeper and start being proactive with your money (see steps 1 and 2). With a little focused intensity and effort, you can save up some money pretty quickly.
Admit it – if it’s really important enough to you, you can sacrifice a little and save some money, can’t you?
Of course, you could just buy some insurance for some of these types of events. For instance, you can buy short-term disability insurance, lower your deductibles on your house and cars, pay higher premiums for lower deductibles on your health insurance, purchase supplemental health insurance, etc. But you’re going to pay quite a bit in extra premiums to cover every emergency. And guess what? You’re still going to have extra expenses that aren’t covered by the insurance.
When you’ve built up a good emergency fund equal to 3-6 months of your household expenses, you’re effectively self-insuring against a variety of financial emergencies. You’ve now got the cash on hand to handle the expenses from these events without worrying about going deeper in debt.
Let’s give some examples here. With 3-6 months of expenses sitting in a bank account (somewhere between $10,000 and $20,000 for most families), you can lose your job and have six months of leeway to find a new job. When you have medical expenses, you can cover the deductible plus your 20% of the expenses. Better yet, you can save money with a high deductible plan and be confident you can cover the deductible.
With a 6 month emergency fund, you can get hurt on the job and have your own short-term disability policy in effect. When the car breaks, you can either fix it or replace the whole car. When the roof leaks, you can replace the whole roof and confidently search for contractors based on quality of work, not availability of financing.
Perhaps most importantly, when you’re self-insured with an emergency fund you have peace of mind and the ability to sleep better at night. Think about the causes of stress in your life. Financial issues tend to be one of the top sources of stress.
Would you sleep better knowing you won’t have to go into debt if an unexpected event happens? If you answered yes, I strongly recommend you build up an emergency fund. If you answered no, are you in denial or just a free spirit?
It’s not a question of if you’ll need an emergency fund. It’s a question of when.