Do you know how you will pay for an unexpected expense?
According to research by economist Atif Mian and financier Amir Sufi, 40% of Americans could not come up with $2,000 if an unplanned expense arose in the next month.
But everyone will experience a surprise bill at some point, whether or not they have the money for it.
That’s why all budgets should be able to absorb these kinds of costs without forcing you to decide between fixing your broken tooth and buying groceries for the month.
Rather than let an emergency or surprise expense derail your budget, here are some ways make sure your finances stay on track:
Defining Unexpected Expenses
The first step to protecting your budget from financial surprises is to know the difference between an emergency expense, an irregular expense, and a miscellaneous expense.
Emergency expenses are urgent costs that you must take care of, and that are completely unforeseeable. For instance, if your only pair of glasses loses its lenses, that constitutes an emergency expense.
Irregular expenses are predictable, but do not necessarily occur every month. Quarterly bills, annual membership dues, and other expenses that crop up regularly (but not monthly) are all irregular expenses. These types of expenses can be easy to forget about, making their due dates feel like an emergency if you have neglected to budget for them.
Miscellaneous expenses are non-critical but unpredictable expenses. For example, having to pay for your child’s little league uniform or replacing the toner in your printer can both be examples of miscellaneous expenses.
Once you have identified which category an unexpected expense falls into, it becomes much easier to plan ahead for it.
Start with an Emergency Fund
If you haven’t already, start an emergency fund. Most experts agree that you need at least $1000 in an emergency fund to start, but you should aim for 3-6 months worth of expenses. Once you have a cushion of cash to insulate you from life’s expensive difficulties, you’ll be able to focus on keeping your monthly budget in order.
Prepare for Irregular Expenses with Targeted Savings
If you find yourself scrambling to pay for your child’s day camp each summer, creating a targeted savings account for that—and any other irregular expense—will make sure you always have the money when you need it.
To create your targeted savings, look back at your expenses over the past year to three years, and make a note of all the irregular expenses you have had to pay during that time. For each expense, divide the total by the number of months between each expense. (So your child’s camp bill will be divided by 12, since you only pay it once per year.) Set aside the monthly amount into a savings account, and the full amount that you need will be available once the bill comes due.
In addition to the predictable but irregular expenses, it’s also a good idea to create targeted savings for inevitable but unpredictable expenses. For example, while you might not have any particular idea when your car might need repair, setting aside $100 per month into a car repair budget category will ensure that you can pay for an unexpected repair. In addition to car repair, plan on also creating targeted savings categories for home maintenance, medical, and gift expenses.
Have a Miscellaneous Budget Category
In addition to an emergency fund and targeted savings, it’s also a good idea to build a miscellaneous expenses category into your monthly budget. This is one of the most difficult budgeting categories to get right, because the word “miscellaneous” can cover any number of bad spending decisions.
As with targeted savings, the best way to create a useful miscellaneous budget category is to start with previous years’ expenses. Look over your expenses from previous years, and add up the miscellaneous expenses from that time. You will not be able to extrapolate exactly how much you will need for miscellaneous expenses in a particular year, but it’s a good idea to see what non-emergency, non-irregular expenses blindsided you over the past few years.
Once you have done this, you will then have a goal to shoot for. For instance, if you find that you’ve regularly spent $1,500 each year for life’s little problems, then you know you will need to set aside $125 per month in your miscellaneous budget category.
Since this budget category can get out of hand, plan on asking yourself with each miscellaneous purchase if it is absolutely necessary. That question can help prevent you from abusing your miscellaneous budget category.
Reassess Throughout the Year
Reassess your needs once or twice a year. Did your car pass the 100,000 mile marker in the past six months? Can you tell that the slight twinge in your incisor isn’t going away? You may need to adjust your emergency, irregular, and miscellaneous budget categories up or down depending on what needs you think might be coming in the future.
Don’t assume that once you’ve set your budget up, you can consider yourself done. Continue to tweak as you keep better records and learn more about what your particular needs will be.
Other Ways of Dealing with Unexpected Expenses
Find free or low-cost ways of dealing with these issues. If you haven’t had a chance to really build up these budget categories when life drops a bill in your lap, you may still be able to get back on track without having to blow your budget.
Dental schools are always in need of patients for their students to practice on. Each graduating dentist must have completed at least one of every type of procedure available before he or she can walk across the stage-and patients often don’t have to pay a dime for the care.
Call your local university to see if they are in need of dental patients. Similarly, vocational and technical schools need the practice in diagnosing and working on cars. Your funny engine noise could help teach a budding mechanic, and having him fix it could cost you a great deal less.
Planning Ahead for the Unexpected
Unfortunately, surprise bills are a fact of life, but they don’t have to destroy your financial plans. As long as you plan ahead for the unexpected, you’ll always be ready for it.
What about you? How are you dealing with unexpected expenses?