Hi I was wondering if you could cover this in your blog, a lot of PF bloggers talk about having an emergency fund and savings, and I’m wondering what is the difference?
Isn’t the purpose of saving so that when life emergencies happen you have savings to pull from?
It just seems confusing when PF bloggers say you need savings and an emergency fund.
Thanks for your question, Jaime, and you are exactly right on both counts: it is confusing because it is all savings in the end.
The only difference made is in the purpose of each.
Savings are for Planned Expenses
Examples: Rent for the next month, Upcoming trip, New Laptop
These are expenses that you know are coming up, and you are slowly saving aside your money for. They are things that are both essential and non-essential, and are generally used for short-term expenses (within a year or two).
Emergency Funds are for Unplanned Essential Expenses
Examples: Car breaking down, Emergency trip to attend a funeral, Losing your job
These are expenses you didn’t expect, but have a just-in-case cushion for. They are only essential expenses, which means unless you lose your source of income, you should not use the money to cover next month’s rent, because you know that rent is an expense that occurs monthly so it shouldn’t be a surprise when it does.
It is also not to be used for buying a new pair of shoes even though you didn’t expect to fall in love with them, because it isn’t an essential expense, and that’s what your short-term savings fund should be used for.
Why separate the two?
A lot of people like to keep separate accounts for each, because it makes it easier for them not to be tempted to draw from their Emergency Savings.
If you keep your Emergency Fund in ING Savings (earning a paltry 1.2% interest right now), and you know that’s exactly how much you need to cover your basic living expenses and emergencies for the next 3 months to 2 years.
Then leave it and log in occasionally to marvel at how much money you’re earning just by letting it sit there and accumulate in interest.
Then you can keep the rest of your money in another account (even at a different bank so you don’t see the balance at all), and feel comfortable drawing on whatever is in your savings as you see fit.
…but don’t feel obligated to do it!
I don’t — partly because I’m lazy and partly because my income is unplanned, so I never really know what I am going to make until I secure a contract, and even then, contracts can be cancelled.
I note the difference in my Monthly Budget Roundups, but I consider my ING savings to be both Savings (mostly for essential things like paying for rent) and also for Emergencies, due to the nature of my income.
The things to keep in mind for the above are:
- Knowing how much you spend each month so you can approximate if you need to save more
- Keeping your monthly expenses low; yes it’s one big slush fund to draw upon, but it isn’t all play money
- Keeping track of your money with a budget, so you can see red alerts in your spending & rein in
Keep both funds in cash or cash-like reserves
You might feel the urge to put your emergency fund into some locked-in investment, but tread carefully, because you want to be able to pull out the money at almost any time within a short-term time frame, like 1 – 2 years.
If you buy bonds with your emergency fund for example, and they’re locked in for 2 years, what if something happens in between that time period?
You won’t be able to draw out your money as easily as if it were in cash, or a cash-like reserve.
If you do decide to buy bonds or something similar like GICs (Guaranteed Investment Certificates), then make sure they will be able to be withdrawn in under a year, something like 3 or 6 months.