Are Emergency Funds A Bad Idea?

Are emergency funds bad

Blog (MP) Traditionally, we’ve been cautioned by financial experts to always have emergency funds on hand, well, in a case of an emergency such as job loss. However, this kind of financial thinking may be changing. Many believe because of consistent investing, rising markets, expanded investment technology and ready access to credit lines and student debt, saving for emergencies may have gone the way of the dinosaur.

The first step along the way is to understand what an emergency fund is. Emergency funds are monies that you’ve saved up for the sole purpose of helping you sustain financial normalcy while going through emergencies. Most of the time, you shouldn’t touch the emergency fund at all – it’s suppose to sit there earning a bit of interest and waiting until you really need it.  When you lose your job. When the refrigerator breaks down or the car needs repair.

Let’s consider arguments for eliminating emergency funds

In recent years, particularly with the growth of investing and new investment products and applications, arguments have been made disputing the need for emergency savings.

You can always tap a credit line. Since credit has become so widely available in recent decades, there is a belief that unused credit lines can function as emergency savings. This is particularly prevalent since so many people have credit cards with available balances. This enables you to tap emergency cash only when it is needed and without having to have a reserve available for that purpose.

The return on safe, liquid investments is poor. With the decline in interest rates over the past three decades, the return on safe, liquid interest-bearing accounts has been admittedly poor. Accounts such as savings accounts, money market funds and short-term certificates of deposit (CDs) are well below 1% per year. Since that is a guaranteed money loser when you factor in inflation, the thinking is you should understand Saving Money vs Investing Money before engaging in emergency savings.

A Roth IRA can work like emergency funds. Since contributions to a Roth IRA are not tax deductible, you can withdraw them at any time without having to pay regular income tax or an early withdrawal penalty. In this way, the Roth IRA functions as both a retirement plan and emergency savings.

If you’re rich you don’t need emergency savings. Generally, if you have a large enough asset base, emergency savings are unnecessary. The thought is that there is almost always an account somewhere that can be diverted to cover short-term emergency money needed.

You should clear student debt first. It’s easy to insist that emergency funds are critical for everyone while ignoring the average household’s financial situation.  Example, if your family is carrying credit card debt, student loan debt, or both, then building cash reserves for the purpose of anything other than paying down those debts is not good financial practice.

Arguments for staying the course

You lose your job. A sudden and unexpected loss of a job can be a devastating experience for both your finances and your self-esteem or maybe you chose to resign because of your job. Whatever the reason, you need a way to pay your bills until you establish another source of income–and your emergency fund should be it.

Your car breaks down. When your main mode of transportation is compromised, it’s a bigger issue than being unable to hit the drive-thru on your lunch break. It compromises your ability to get to work, to care for your family, to stay safe. As such, it needs to be fixed immediately. Or, in a worst-case scenario, replaced. Your emergency fund means you won’t have to go into debt to do so.

You get sick.  Did you know that in many cases, you have to pay for some or all of an ambulance ride to the hospital? (And if you don’t have health insurance, it’s even more likely you’ll be responsible for covering the whole cost.) If you get hurt enough to spend time in a hospital or emergency room–maybe even hurt enough to need surgery and physical therapy–you can’t always rely on insurance to cover the full cost.

Death in the family.  No one likes to plan ahead for attending funerals, but if someone you love does pass away suddenly you want to be able to afford the plane ticket. Or suppose you have to travel to and pay for the funeral, burial service, roses or any other bereavement-related expenses, your emergency fund can step in and save the day.

Your house needs repairs. If you own your home, you know that there are few things more discontent than watching the paint chip and crack above your head.  It’s right up there with discovering a backed up sewer line in the basement or setting the kitchen on fire before a particularly anticipated anniversary party. First, check your homeowner’s insurance but, afterward, if an unexpected home-related expense appears, rest assured that’s why you have your emergency fund.

Bottomline:

An emergency fund is a big pot of gold that buys you time. If something terrible happens, like losing your job, your emergency fund is there to cushion you during the situation. It also allows you to be patient and pick the best job for you, not just the first employer that wants to hire you. Just make sure your fund is a savings account with no other purpose. That means staying away from stocks or bonds or mutual funds. You want to be able to access your money at any time without the danger of having to sell an investment for less than what you bought it for.

Resources:

Why Emergency Funds Are A Bad Idea

Why You Need An Emergency Fund

A Quick Guide To Your Emergency Fund

My Emergency Fund Plan

Don Briscoe
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Don Briscoe

Finance educator, advisor, and leading voice in the global financial literacy movement.Founder and editor of MoneyPacers.com.He lives and enjoys life with his family in New York.
Don Briscoe
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