Liz Weston* says it’s a good idea to create an ‘Oh, crap!’ fund — a savings account for not-quite-emergency expenses that can keep you from turning to credit cards or payday loans.
Photo: Muhammad Irfan
The emergency fund is a bust.
Millions don’t have one, and some of those who do resist tapping what they’ve saved.
I’d like to propose an alternative for both sets of people: The “Oh, crap!” fund, a savings account for not-quite-emergency expenses.
One of the reasons people don’t have emergency funds is misplaced optimism.
People think that if they’re healthy, they’ll stay healthy.
If they’re employed, ditto.
The car will keep running, the roof will never need to be replaced and, since everybody’s a better-than-average driver, there won’t be any accidents.
Behavioural scientists call that “recency bias,” which is the delusion that whatever happened in the recent past will continue into the indefinite future.
Everyone, though, has experienced “oh, crap!” moments: the no-parking sign they didn’t see, the crown the dentist says they need, the smartphone dropped in the toilet.
A relatively small amount in such a fund can keep people from turning to expensive credit cards or payday loans.
“The power of just a few hundred dollars of savings can really help reduce the use of short-term, high-cost lending,” says John Thompson, chief program officer for the US Center for Financial Services Innovation.
Having a cushion is particularly important if you’re a homeowner.
In a recent Harris Poll survey commissioned by NerdWallet, nearly two-thirds of homeowners say they’ve experienced anxiety about their home, with unexpected home repair costs the top cause of anxiety.
The “Oh, crap!” fund is designed to be spent, not hoarded.
Emergency funds are meant to be spent, too, but people are often reluctant to part with money labelled as savings, says financial literacy expert and Rutgers University Professor Barbara O’Neill.
“People hate to experience losses, [and] pulling money out of a savings account feels like a loss,” O’Neill says.
Many people also give up on the idea of an emergency fund because any money they manage to put aside is quickly wiped out by unexpected expenses.
They don’t realise that the emergency fund did its job by keeping those expenses from going on a credit card, or that saving for unexpected expenses is a “rinse and repeat” deal.
You don’t just hit a savings goal and you’re done.
You save, you spend, and then you save again.
The “Oh, crap!” fund can help people build that muscle.
It can be viewed as a transactional account with constant additions and subtractions as life unfolds.
The fund also can help people who already have savings they don’t want to touch except in big emergencies, such as a job loss.
The first “Oh, crap!” goal can be pretty modest, say $500.
For those new to saving, here’s how to get there.
Set up a dedicated account.
Consider using an online bank, since most don’t have minimum balance requirements or account fees.
Some prepaid cards have a savings feature if you don’t use bank accounts.
Automate it, if you can.
Those with regular paycheques and bank accounts can set up automatic transfers, so $10 or $20 or whatever amount you like gets swept into a savings account each pay period.
Or you can use technology that automatically rounds up your purchases to the nearest dollar and deposits the money in savings.
If you can’t automate, make a rule.
Decide to put aside a set dollar amount or percentage from every paycheque or other income you receive.
Examples: “I’ll save $10 from every paycheque and 10 per cent of any windfalls.”
Don’t stop.
Once you’re in the habit of saving, keep going.
Your next goal can be $2,000, which is the median cost of the largest financial shock experienced by households studied by the Pew Charitable Trusts.
After that, you can shoot for the traditional emergency fund recommendation of building a fund equal to three months’ worth of expenses.
Even as you do, though, you may still want to keep a separate fund for those everyday mishaps.
Because crap happens.
* Liz Weston is a columnist at NerdWallet. She tweets at @lizweston.
This article first appeared at www.nerdwallet.com.
