Review, Recalculate, & Replenish Your Emergency Fund
In order to do its job, your emergency fund needs enough 'fund.' Whether or not you've used your emergency fund within the past year, you should do an annual review of your funding needs and fund amount.
The purpose of your Emergency Fund is to provide a buffer for you and your family should, well, an emergency happen. But if you haven't checked in on your fund for a while, you could have an unpleasant surprise when an emergency comes.
If You Haven't Used Your Fund
Even if you haven't had an emergency, you may not still need to increase your emergency fund due to drift. Drift is a concept from investing where natural changes alter your strategy. Inflation, lifestyle changes, changes in your expenses, and career changes can all increase the funding needs for your emergency fund.
Changes to Income
Any major changes in your income can change your emergency fund needs. Increases in income are often accompanied by increased spending. This will require you to grow your emergency fund at the same rate your income and lifestyle grew.
Additionally, you or your spouse may have decided to cut back or quit work to spend more time with children. Reducing or removing an income from you household creates a greater risk associated with the remaining income stream. If this is the case, it will be important to increase your emergency fund to compensate for that risk.
Changes to Expenses
Any changes you've made to your budget or expenses will also require a modification to your emergency fund. If you have increased your rent or purchased a new home, your emergency fund will have to be adjusted to compensate for the increased housing expenses. Similarly, if you purchased a new car or took on any additional debt, you may need to increase your emergency fund to cover those mandatory expenses should you experience a job loss.
Finally, review your discretionary expenses to see what new hobbies or interests you've added to your spending. If you built your emergency fund to be able to cover fun expenses during a job loss, you want to expand your emergency fund so that you can maintain your lifestyle during the period of unemployment.
Inflation will also require you to expand your emergency fund on a regular basis. Although inflation will not require significant contributions to the emergency fund, it is doubtful that the savings, money market, or CD accounts are paying an interest-rate that is keeping up with inflation. As a result, you may need to put in an additional 1% to 2% each year so that inflation doesn't slowly eat away at the purchasing power of your emergency fund.
You should also review your financial situation, family health, job stability, and other aspects of your life to determine if a looming risk might force you to use up your emergency fund. For example, if you've recently changed jobs or careers, your job security has likely decreased significantly. Hints that an emergency might be coming should trigger you to consider increasing your emergency fund as an additional buffer against the risk.
If You Had an Emergency
If you did end up using your emergency fund recently, replenishing your emergency fund back to its former glory should be a top priority. Review how much of your emergency fund you used, the amount of funds that are left, and your current emergency fund needs. Use this information to calculate the dollar amount to be added to your emergency fund so it can fully cover the risk of a job loss.
Set a Refill Plan
Once you have the dollar amount, set a plan to refill your emergency fund as quickly as possible. Obviously, this should not come at the expense of other necessities, but it should be one of your high priorities for the year. Identify when you want to complete the replenishment of your emergency fund by and calculate how much each month you will need to put away in order to achieve that timeline. Then, make the savings effort a part of your monthly budget (and consider setting an automated transfer on payday).
In order to accommodate this new budget expense, identify expenses or wishes that you can put on pause. Also identify budget items you don't want to give up, but you can cut back on temporarily while you replenish your emergency fund.
As a last resort, consider putting off funding retirement or education funding for your children. This should only be done if you have no other options for replenishing your emergency fund. Investing for your retirement and for your children's education should be your top priority. Make sure you've cut everywhere else before you consider touching these investments.
Kill Any Debt
No matter how debt averse you are, the emergency may have caused you to go into debt and run up charges on your credit card. Emergencies have a funny way of causing debt to creep up on even the best debt manager.
If the emergency ate up your emergency fund, you may have had to rely on credit cards to carry you through. And you now carry a balance. If this is the case, killing that balance should be a priority even above replenishing your emergency fund. The interest-rate that you pay on credit card debt or on a personal loan will be dragging down your overall budget, making it that much more difficult to replenish your emergency fund.
Focus all of your efforts on eliminating the debt, thereby saving you future interest charges. Once the debt is cleared, you can put all the debt repayment money towards rebuilding your emergency fund. Your ability to replenish your emergency fund will be greatly amplified when you don't have credit card interest charges working against you.
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