How to Budget for Unexpected Expenses
I received some very sad news from one of my young coaching clients this week, a close relative had died unexpectedly and as next of kin, she was responsible for funeral arrangements.
While funeral costs would ultimately be reimbursed from the estate, the initial costs would be my client’s responsibility. As a reasonably new client, she was emailing me was to ask how she should factor all these unexpected expenses into her budget.
Unexpected Expenses are a Part of Life
‘How to Budget for unexpected expenses and emergencies’ is understandably one of the most common questions I get asked as a budget coach.
This tragic incident is a prime example of the fact that we simply cannot budget for or anticipate every expense that will come our way.
You Cannot Budget Specifically for the Unexpected
Unexpected expenses do occur – you don’t know what they will be, how much they will be or when they will occur – but you can be certain they will occur.
Knowing and accepting that unexpected expenses will occur is a big part of the battle. While we cannot specifically budget for unexpected expenses we can and should plan for them.
So How do you Budget for Unexpected Expenses?
Here are the two steps that I take all my clients through to help them prepare for unexpected expenses:
Step # 1- Budget thoroughly for what you do know
Firstly, make sure you have a thorough understanding of what ALL your known expenses really are.
Only 5-10% of the expenses you will face each year are truly unexpected, that means that 90-95% are completely predictable.
Taking the time to thoroughly understand your expenses will ensure your potential list of ‘unexpected expenses’ is minimised to the ‘truly’ unexpected.
Step # 2- Build a ‘Rainy day’ fund
To cover the 5-10% of expenses you truly can’t anticipate you need to establish a rainy day fund.
Depending on your life situation, a rainy-day fund should be anywhere between $2,000 and $5,000. These funds should be set aside in a high interest savings or offset account. The sole purpose of these funds is to cover those inevitable unexpected expenses and emergencies.
Build Your ‘Rainy Day’ Fund Before You Pay Off Debt
I have a very strict but effective process that I take all my budget coaching clients through to ensure they make sustainable progress. This is my 6 step Road map to financial Peace
- Income must be greater than Expenses
- Your Budget must be backed up my money in your bank account
- Build a Rainy Day Fund of $2,000 to $5,000
- Eliminate Lifestyle Debt
- Grown your Rainy Day fund to a 3 month Cash Reserve
- Set and Achieve Financial Goals.
This process is powerful and very deliberate, your Rainy Day fund must come before you start eliminating debt.
Unexpected Expenses will not Wait for You to Pay Off Your Debt!
Having a rainy-day fund will provide an all-important buffer when it comes to paying off debt.
Too often I see people throwing all their ‘savings’ at their debt but they have nothing to back them up ‘if’ or should I say ‘when’ an unexpected expense comes along. So please make building a rainy day fund your priority.
You Can Be Prepared Without Knowing What Unexpected Looks Like
It is a fact of life that unexpected expenses will occur, and while we cannot anticipate or budget for every eventuality, we can be prepared.
The simple place to start is to ensure that you have a comprehensive understanding of your expenses so you can budget effectively for the 90-95% of expenses you can anticipate.
Once you have a thorough budget in place you then need to make it a priority to channel your savings into building a rainy-day fund of $2,000 to $5,000 to cover that 5-10% of expenses you simply cannot anticipate to budget for.
This rainy day fund is not to be touched for any reason other than a genuine emergency; it is your insurance against the unexpected, and will ensure your budget is not derailed when the inevitable occurs.