Starting an emergency fund is often emphasized, but generally not much is documented in the literature about when you should tap into that money. Let us discuss what you need to know about deciding when it is time to withdraw money from your emergency fund.
Job loss and income reduction
Job loss is one of the biggest financial emergencies. Owing to the pandemic, there is a significant negative impact on industries across the spectrum. When you lose your job, you need to tap into your emergency fund to cover living expenses such as housing, food, etc. Sometimes, you may not lose the job, but might end up with reduction in working hours or a salary cut. In such a scenario, you may need to cover the gap by dipping into your emergency savings.
Medical bills and major repairs
Medical bills are a major source of stress and financial distress. In spite of having adequate health insurance, often one ends up getting into co-pay and cover those expenses which are not covered in the insurance terms and conditions. In such a scenario, it might make sense to turn to your emergency fund to pay your uncovered portion of medical bills.
If your job profile requires extensive travel by car or bike, you might need to access your emergency savings to pay for any unforeseen repairs of your vehicle. Similarly, there is an urgent need to buy a new appliance if there is a major breakdown. So, tapping into your emergency money to cover these expenses could be a better option than using a credit card and carrying a balance with a higher interest cost.
Avoid spending on non-essential items
One should be careful on what to term as an emergency. As times are stressful right now, it still makes sense to take a step back and review whether you are spending on needs or wants. Try to avoid using your savings on nonessential items. A good way to check the same is to ask yourself the question of whether you actually need it to survive. If not, think twice before using emergency fund money for the purchase.
Another way is to review your spending trends over the past couple of months and then identify the least important expenses. Those are costs that can be cut in the event of an emergency so as to reduce your overall cash outflow and need to tap into your emergency funds.
Re-build your emergency fund
It is equally important to rebuild your emergency fund. You probably can not replace the money you have used at one go, so it is good to start small. Compute how much you can put in each month irrespective of the amount. Once your financial position is stable, try to increase the amount you set aside and bring back the emergency fund to the previous levels.
You could probably build up your emergency fund faster if you get a bonus at work or some other unexpected money, tax refund, etc., and use a portion of the same to replenish your emergency fund.
To conclude, the pandemic is subsiding slowly, and life is gradually returning to normal in spite of the threat from Omicron. One could use the above dos and don’ts with reference to emergency fund because the prerequisite to any investing is to have an emergency fund.
The write is a professor of finance & accounting, IIM Tiruchirappalli