We're told we're supposed to have money set aside for the unexpected, whether it's an unplanned car repair, a leaky roof, or the sudden loss of a job. But while many Americans are -- thankfully -- establishing emergency funds, a large number are tapping those cash reserves for the wrong reason.
In a recent GOBankingRates study, 23% of adults aged 18 to 24 said that they've used their emergency savings to pay for cost-of-living increases -- things like their rent going up or their utility bills rising. In doing so, however, they're harming their finances more than they know.
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The right time to use your emergency fund
A strong emergency fund is one with enough money to cover a minimum of three months' worth of living expenses, and ideally, more like six months' worth. So let's assume you've managed to accumulate the latter, but then you get hurt and find yourself on the hook for a number of costly medical bills. If those bills well exceed what your paycheck enables you to cover, it makes sense that you'd dip into your emergency fund to pay the difference. After all, that's what that fund is there for. The same holds true if your car breaks down, your heating system goes kaput, or your company decides you're no longer employed there, effective immediately.
What that money shouldn't be used for, however, is predictable expenses. And you can pretty much bet on your cost of living going up over time.
Think about it: It's not unusual for a landlord to raise your rent once your lease is up, or for your cable company to impose a higher rate once your promotional package expires. Cost-of-living increases are not only normal; they're reasonably predictable, which is precisely why your emergency fund shouldn't be paying for them.
Remember, the purpose of having that safety net is to protect you from the unknown. But if you use your cash reserves to cover things like an increase in rent, you'll have less money available when true emergencies strike.
A smarter approach to managing your living costs
Since it's likely that you will see your living costs rise from year to year, a better bet than using your emergency fund to pay for those increase is to build some wiggle room into your budget. The majority of Americans today take on so many expenses that they're maxing out their paychecks month after month. If instead of spending 100% of what you bring home, you limit your expenses to 90% of your income, you'll have some flexibility for when your bills inevitably go up.
Furthermore, if you don't spend each paycheck you receive in its entirety, you'll have a better opportunity to boost your emergency fund for further protection against life's curveballs. Imagine you currently have three months' worth of living expenses socked away. That's a respectable effort, but what happens if you lose your job and don't find a new one for four or five months? Suddenly, that emergency fund isn't enough, and you may find yourself having no choice but to resort to credit card debt to cover the bills until you're reemployed. Therefore, if you have an opportunity to lower your expenses and boost your savings in the process, it pays to go for it.
Remember, your emergency fund, by nature, is for expenses you can't possibly foresee. So, don't use it when your bills go up. Rather, take steps to lower those bills in the first place, and keep them as low as possible going forward.
