You might be asking yourself, “Should I build my emergency fund or pay off debt first?"
If you're debating between paying off debt or saving more cash, your emergency fund should come first! You heard that right,debt—we’ll deal with you later (soon, but later).
See, they’re both good options, but there is a gooder, er, better option. Whenever you’re dealing with multiple financial goals, they all elbow for your attention (and your dollars). But there is a method to this madness, and that’s what I’d like to talk about today.
Should I Build My Emergency Fund or Pay Off Debt First?
Before we can talk about saving for emergencies or crushing your debt to smithereens, there’s the matter of your basic needs:
1. Cover Your Basic Needs
First things first, you have to cover your essentials with the dollars you currently have. These are things that:
- Are a need
- Are guaranteed to happen
- Repeat every month
Typically, they’re expenses related to survival:
- Groceries
- Utilities
- Rent
- Minimum payments on debt
And how far out are they covered? Just next month? If you’re faced with uncertainty around income, you might want to stop at this step and use your cash to cover these essentials a few months out. Once you’ve got those covered, you move on to…
2. Cover Your Non-Monthly (But Necessary) Expenses
These expenses are the purchases that you know are coming, but they don’t happen every month.
These might be things like:
- Auto maintenance
- Trash service
- Car insurance
When you’re looking at the total cost of a month of your life, you want to include these one-off expenses. You can think of this as preventing future debt. By breaking these larger costs down into monthly chunks, it’s not a huge blow when the multi-hundred dollar bill comes due. You’ll have the money already set aside and it won't need to go on the credit card.
Why Saving for the Basics Matters So Much
It’s easy to see why paying our monthly bills is the top priority. You need a roof over your head, and food to keep you alive. But what about those irregular expenses? It’s harder to put aside dollars for car repairs when your car seems totally fine—especially when you’re wrestling with debt!
The thing is, if you don’t fund your car repair category now, it could (easily) lead to new debt. I’m not a sports guy, but a sportsing analogy is perfect here: Imagine a football team that’s really good at playing offense. I mean they’re killing it! But when it comes to their defense, the coach shrugs and says, “Meh, let’s just not put any players on the field.”
Well, they’re going to lose, right!? And that’s just the truth. The same is true with our money. You gotta play some defense (read: avoid new debt) before you’re ready to go on offense (read: pay off debt).
3. Build Your Emergency Fund
If you think about it, your emergency fund is just another one of those larger, less frequent expenses—except you don’t know what it’s for. Murphy’s Law correctly reminds us that things will happen (we just don’t know when or how much they’ll cost). Maybe your new-ish car’s battery will bite the dust. Maybe your crazy dog will impale herself with a stick (true story, my dog’s ok, thank you). Or, an unexpected global pandemic directly impacts your income (we definitely didn’t see that one coming).
So should you pay off debt or save more cash? Well, here comes the drumroll...
Your emergency fund should come first! You heard that right, debt—we’ll deal with you later.
So, if you’re paying attention, you budget in this order:
- Basic needs (like rent or minimum debt payments)
- Non-monthly but necessary expenses (like car repairs or health savings)
- Emergency fund (you decide the right size, based on your current circ*mstances)
So How Big Should My Emergency Fund Be?
Some gurus say an emergency fund should be $1,000 to start, some recommend a more sizable 3-6 months of living expenses. Your emergency fund might just be whatever cash you have on hand right now.
4. When Income is Uncertain, Up Your Cash Cushion
In the midst of uncertainty around income, it’s worth considering hanging on to cash—even more than you would normally. It might be more important right now to know you’re covered for a few months of essential expenses than knocking back your debt balance.
- If you were planning a big debt paydown but your future income is uncertain, consider hanging onto that money to build a bigger emergency fund instead.
- If you’re in the middle of debt paydown, consider backing off if you don’t have a few month’s worth of living expenses in the bank.
Having more cash buys more time. If you’re facing reduced income, more cash gives you more time to calmly decide what to do. This usually results in better decision making.
Right now, you might be feeling a loss of control. You can’t control whether or not you’re going to lose your job, be furloughed, or see a pay cut, but having cash creates more options that give you some of that control back. This isn’t just powerful financially, but emotionally too.
That’s because money in the bank is a concrete certainty, and this can be comforting. You can stretch your cash, but you can’t stretch cash you don’t have.
If you’ve got a healthy cash cushion already and your income seems stable, there’s nothing wrong with continuing your debt payoff as planned. Just know it’s OK to cut back and increase your cash cushion should anything change.
5. Things Change? Change Your Mind
The beauty of this approach is that by prioritizing cash, you’re not making a permanent decision. If you decide to hold off on paying debt to build a bigger cushion in uncertain times, you can always change your mind later and put that money towards debt when things get more stable. But you can’t change your mind if you put all that money on debt now. That is a more permanent decision.
Still Have Questions About If You Should Build Your Emergency Fund or Pay Off Debt?
If you want to learn about debt, check out our free Debt video course with short, bite-sized lessons so you can get out of debt (and stay out!).
As someone deeply immersed in the world of personal finance and financial planning, I can unequivocally affirm the critical importance of addressing the dilemma posed in the article: "Should I build my emergency fund or pay off debt first?" This question is emblematic of the broader challenges individuals face when navigating multiple financial goals. Allow me to delve into the concepts presented in the article, drawing from my extensive knowledge and practical expertise.
Cover Your Basic Needs: The article rightly emphasizes the significance of covering essential expenses first. These include needs that are guaranteed to happen, repeat every month, and are crucial for survival. Examples cited, such as groceries, utilities, rent, and minimum payments on debt, align perfectly with the fundamental principles of budgeting. This step ensures a stable foundation by meeting immediate obligations and mitigating the risk of financial instability.
Cover Your Non-Monthly (But Necessary) Expenses: Acknowledging non-monthly yet necessary expenses is a prudent approach to prevent future debt. The article highlights items like auto maintenance, trash service, and car insurance as examples. By breaking down larger, irregular expenses into manageable monthly chunks, individuals can proactively allocate funds and avoid resorting to credit cards when these expenses arise. This reflects a strategic mindset toward financial planning.
Importance of Saving for Basics: The article aptly underscores the challenge of setting aside funds for irregular expenses, drawing a parallel with the necessity of playing defensive strategies in sports. The analogy effectively communicates the importance of financial defense – preventing new debt – before focusing on offensive strategies such as paying off existing debts. This nuanced perspective is invaluable in fostering financial resilience.
Building Your Emergency Fund: The central thesis of the article revolves around the prioritization of the emergency fund. The unpredictability of life events, as highlighted by Murphy's Law, necessitates the establishment of a financial safety net. Whether it's a car repair, unexpected veterinary expenses, or the global shock of a pandemic, the emergency fund serves as a buffer against unforeseen circ*mstances. The article wisely recommends determining the appropriate size of the emergency fund based on individual circ*mstances.
Adjusting Strategies in Uncertain Times: The article offers insightful advice on adjusting financial strategies during periods of income uncertainty. Prioritizing a larger cash cushion over aggressive debt paydown is a pragmatic approach in times of flux. The flexibility to reevaluate and change course based on evolving circ*mstances underscores the adaptability required for effective financial management.
The Power of Cash in Uncertain Times: In uncertain times, the article advocates for a heightened emphasis on maintaining a robust cash reserve. This not only provides a financial safety net but also empowers individuals to make more considered decisions. The article recognizes that having more cash extends the time available for decision-making, resulting in better financial choices.
Adaptable Decision-Making: The beauty of the recommended approach lies in its adaptability. Prioritizing cash does not entail a permanent decision. Individuals can pivot between building an emergency fund and paying down debt based on changing circ*mstances. This flexibility allows for responsive decision-making, a crucial aspect of effective financial management.
In conclusion, the article provides a comprehensive framework for navigating the complexities of managing finances, combining practical wisdom with a strategic approach. The concepts outlined underscore the need for a balanced and adaptable financial strategy, positioning the reader to make informed decisions in the dynamic landscape of personal finance.
