Personal Finance Tip of the Week, By Financial Fundamentals, LLC of Watertown

​In order to prepare for financial emergencies, you will want to have a smart solution to respond to all sorts of unexpected events - both large and small.

Your solution will probably involve more than an emergency fund alone. An emergency fund is a dedicated source of funds that you can use if something unexpected occurs. Examples might include unexpected car repairs, medical bills, tax bills, a reduction in work hours, or even a short job layoff. Having an emergency fund allows you to pay for these unexpected events in a timely manner without having to resort to credit cards or other savings. This enables you to get through the event without increasing your debt, hurting your credit score, or compromising other important financial goals in your life.

But an emergency fund has limitations. Most people can’t afford to save indefinitely into an emergency fund because they must also make progress on other goals, like a home purchase, college education, or retirement. This means that an emergency fund might be big enough to handle small to medium-sized emergencies, like the examples listed above, but not big enough to handle large emergencies.

Examples of large emergencies might include the disability or death of the main breadwinner in a household, the injury to others in a car accident, or a major medical procedure and recovery period.

This is where insurance can play its own role to help you prepare for emergencies. It can help you handle financial emergencies that are too big for a typical emergency fund.

Insurance companies are generally able to protect you from large losses while charging you a relatively small amount. They can do this because they insure many people, and only a few will actually experience a big loss. The use the profits from many customers to fund the losses of a few.

Common insurance policies that protect you for big losses include property and casualty insurance (auto, renters, and homeowners policies, for instance), disability insurance, life insurance, and health insurance. The cost and complexity of these policies can vary greatly, so it is important to do research, understand the terms and conditions, and get multiple quotes before you buy.

Many people have only partially prepared for emergencies. They may have an emergency fund but no insurance. Or they may have insurance but no emergency fund. Or they may have both, but in insufficient amounts. In all of these cases, they don’t have a complete solution to respond to emergencies large and small.

So if you have a goal to become better prepared for financial emergencies, consider the ways that an emergency fund and insurance can work together to form a more complete solution. Each one plays an important but unique role in your ability to respond to unexpected events.

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Stephen Barkhuff, CFP(R), CFA, MBA is the founder and president of Financial Fundamentals, LLC, based in Watertown, MA. Financial Fundamentals helps couples and singles with modest incomes take control of their financial future. You can reach him at mailto:SBarkhuff@FFundamentals.com.