Derek has studied business administration, psychology, and economics. He writes about personal finance.
One thing that I feel is a very common misconception about budgeting is that it is this rock-solid plan to micromanage every single dollar and there is no room for error or change. In reality, a budget is a “living” plan which changes and adapts to match your specific lifestyle and needs. A budget doesn’t tell you how to live, it ensures you are keeping track of the things you value most so you can continue to enjoy them. In this post, I want to discuss what happens when a budget goes wrong.
How do we protect ourselves from expensive surprises? The Flex Fund and Emergency Fund are the great defenders of our financial lives to make sure we maintain our standard of living in the face of uncertainty. Life is stressful enough with things we already know will happen, so let's protect ourselves a bit from life's lemons.
The Flex Fund
This is your go-to when something comes up that wasn’t specifically budgeted for. Treat yourself to that great sale at the store or take your loved ones to a nice dinner for a special day. The amount you put in here varies but it shouldn’t put a strain on your other budgeted items. Maybe you have a little left over in another account, so you put it in here.
You could even commit to putting a very small amount from your income in the fund. I personally put about 3% of each check to my flex fund. I mainly use it if I go a little over budget in other areas, otherwise I let it build up and if it gets high enough I’ll move some to savings. Its main purpose is flexible money so use it how you wish but this also serves as a test of your entire budget. If you find you are using this money to cover a different budget item or expense regularly then you should consider adjusting your budget. This money may be flexible, but it is not a crutch to rely on, pretend you don’t have it until you need it.
The Emergency Fund
In general, it’s recommended to maintain an emergency fund of around 3 months of expenses. And no, that doesn’t include your vacation. That’s 3 months of necessities and I personally keep 4 just in case. The purpose of this fund is to ensure continuity of your standard of living if something major comes up. Got fired? Car broke down? Need a new heating system? These are all things that can be a major disruption to our finances if we are unprepared for them.
I saw someone the other day who had to take out a $5,000 personal loan to fix her heater. Now that’s an interest-bearing loan that’s costing her 7% on top of the $5,000 she’s going to be paying off for years. She obviously didn’t have an emergency fund. Now it’s important to note this is called an emergency fund because it’s for emergencies only. This is the fire extinguisher you go for when your house catches on fire. This money is not for a shopping spree or a new tv. Use it sparingly and if it is used make sure you fill back up as quickly as possible. Another benefit of this fund is it really drives home living below your means. The lower your expenses are the less you have to put towards the emergency fund and the longer you can last on what you do keep in it.
This article is accurate and true to the best of the author’s knowledge. Content is for informational or entertainment purposes only and does not substitute for personal counsel or professional advice in business, financial, legal, or technical matters.
© 2019 Derek