Considering building up an emergency fund? Here’s my guide to why you should think twice about starting one.
WHY YOU SHOULD THINK TWICE ABOUT AN EMERGENCY FUND
Emergency funds are well known to be one of the big recommendations from personal finance experts. But what’s the reality about building and having an emergency fund? Are they really the best way to manage your money?
WHAT IS AN EMERGENCY FUND?
An emergency fund is money you save in an easily accessible way in case of emergencies like losing your job or major unexpected home repairs.
Personal finance guru Dave Ramsey is possibly the most famous exponent of the emergency fund. He suggests you start an emergency fund by saving $1000 and then aiming to fill it with enough to cover 3-6 months of living expenses.
WHY YOU MIGHT FEEL MORE SECURE WITH AN EMERGENCY FUND
Having an emergency fund is like giving yourself your own insurance. Aside from some insurances being obligatory, we tend to buy insurance policies to feel more secure, to keep anxiety at bay, to know there is already cover in place if an emergency arises.
We also take out insurance if in place of having means whereby we can cover emergency costs. In short, creating your own insurance(emergency) fund removes financial risk and gives you an assured way of coping with a financial emergency.
WHY IT MIGHT BE BETTER TO NOT HAVE AN EMERGENCY FUND
I’m going to make a shocking statement now, ok well it’s not a shock if you’ve read the title of this post… I don’t necessarily believe that an emergency fund is the best way to manage your money. In fact…
I AM WITH MR MONEY MUSTACHE ON EMERGENCY FUNDS
Whilst I have always ensured that I have a rainy day fund, which I admit is equivalent to Dave’s $1000 starter emergency fund, I have never had and never plan to have an emergency fund.
My thinking is much more in line with Mr Money Mustache’s on the subject:
“SOME sort of cushion, or ‘stash’ as we refer to it here, is essential to keep your life smooth even in the event of losing a job or having a big unexpected expense. But it is a huge waste of money to keep money in the bank earning no interest while paying higher interest on debts.”.Quote: Mr Money Mustache
INSURANCE COMES WITH A COST
If you look at an emergency fund as a way of insuring yourself against unforeseen emergencies. The thing to realise is that the insurance policy you’ve created comes with a cost.
REASONS NOT TO HAVE AN EMERGENCY FUND
Whilst it seems very prudent to have a large chunk of cash ready to cover you in the event of an emergency, there are actually several financial downsides to having an emergency fund. The hidden costs of having an emergency fund. Here’s a roundup of a few of them.
1. INFLATION: EASY ACCESS SAVINGS ACCOUNTS EARN VERY LITTLE INTEREST
The advice is that you should have your emergency fund in an easy access regular savings account. The thing is, these accounts have the lowest rates of interest and in the current financial climate, that means tiny amounts of interest that don’t keep your money beating inflation. So, in reality, you are losing money over the years.
2. YOU KEEP YOURSELF IN DEBT IF YOU DON’T USE YOUR CASH TO PAY DEBT OFF
Why would you set aside money to earn a pittance in interest if you have a big pile of credit card debt or student debt to pay off? Even a car loan? Use whatever spare cash you have to pay down debt before you even think about saving large amounts of money.
So, if you’re asking yourself if, for example, you should pay off your student loan or save an emergency fund. I’d say, pay off that student loan.
3. YOU COULD BE MISSING OUT ON TAX ADVANTAGED SAVING
Don’t put money aside for an emergency fund if you can put it into a retirement account like a 401(k) or IRA (individual retirement account). Why? Because that money is missing out on investment earnings. This is particularly pertinent if you have an employer who contributes matching dollars to your 401(k). Why would you forego contributing the maximum to earn the full match each year?
Do also note that IRA rules mean you can withdraw from your IRA at any time should an emergency arise.
4. LOST POTENTIAL INVESTMENT RETURNS
Every dollar that you choose to save in an everyday savings account is a dollar that you are losing out on investing with. Of course investing has its risks, but carefully planned to invest at a rate of risk that you’re comfortable with is an effective way to build your wealth, beat inflation and reach financial freedom.
5. YOU MISS OUT ON OVERPAYING ON YOUR MORTGAGE
One of the biggest steps toward financial freedom is being mortgage-free. Why have money sitting losing value in an easy access savings account when you could be using it to pay down your mortgage. You can usually overpay a certain percentage off your mortgage each year. You could then choose to reduce the monthly payments or better still, keep them as they are and pay off your mortgage early.
HOW TO PLAN FOR EMERGENCIES WITHOUT AN EMERGENCY FUND
Ok, so that’s all well and good. You’ve read my list of reasons that you might want to skip having an emergency fund.
BUT WHAT ABOUT IF THERE’S AN EMERGENCY? WHAT ON EARTH ARE YOU GOING TO DO?????
Well, I’ve put together a list of the things that I would do if a financial emergency arises. I like to call it my emergency armoury. Fancy huh!
WHAT IS IN MY EMERGENCY ARMOURY?
I have several things up my sleeve to cope with emergencies. You will have your own set of circumstances and I’m not suggesting for one minute that you go with any of these. It’s more they are food for thought when you are deciding whether or not to have an emergency fund.
1. KEEPING MY PERSONAL FINANCES WELL MANAGED
I know, I know, how smug am I? But the way I see it, making sure that we are always debt-free and living well within our means is the biggest weapon in my emergency armoury. In fact, to quote Mr. Money Mustache again…
“Newsflash: Your debt is an emergency!”Quote: Mr Money Mustache
Being totally on point with managing our money and keeping out of debt is not going to stop an actual emergency, but it will limit the financial impact and give us more room to manoeuvre. Read my post on how How To Better Manage Your Finances if you think your personal finance management skills could do with a brush-up.
2. RAINY DAY FUND
My rainy day fund hovers at around the $1000 mark. It can be dipped into for unplanned for costs like the washing machine blowing up or the car needing repairs. I top it up whenever it’s getting low. It sits in a savings account that is separate to my main checking account and is listed as a separate item on my money management spreadsheet.
3. HELOC / ADDITIONAL LENDING
We are lucky enough to have a large amount of equity in our home. With the exception of losing our jobs, I know we can always dip into this equity if a major unexpected cost comes up.
4. CREDIT CARD
Yes, I am a MASSIVE exponent of always ALWAYS paying your credit card off in full every month. BUT, I also know that I have my credit card there in case of absolute emergency. The bonus of always having it paid off in full means that there is always maximum credit available. Given that my credit card provider knows I always ALWAYS pay my card off in full each month, it has upped my credit limit to an eye-watering amount. Obviously that’s in an attempt to lure me into debt, but I am too clever for that. Instead, I know that my card is my absolute last-resort emergency relief.
5. SCALE BACK OUR RETIREMENT SAVINGS TEMPORARILY
I would scale back payments into our retirement fund for a month or two until we could get back onto an even keel. We could also withdraw from our retirement savings, but this would be an absolute last resort.
6. DIP INTO OUR VACATION FUND
I have a continual vacation fund, it’s not massive, we don’t tend to spend big on vacations. But I believe in having the money to pay for our vacations up-front. I see this as our supplementary rainy day fund, it’s there if we need it, we can survive without vacations until we’re back up and running.
7. SPEAK TO MY BANK
At the first sign of financial trouble, I would speak to our bank, which our mortgage and bank accounts are with. I always believe in dealing with financial issues head-on, it’s the easiest way to avert catastrophe.
EMERGENCY FUND FINAL THOUGHTS
Clearly, having an emergency fund is a very personal choice. If you think you would feel less anxious and more secure with a sizeable chunk of cash tucked away, then you know that’s the right decision for you at this moment in time.
Just be aware that there are hidden costs associated with building up an emergency fund. Then plan your emergency fund meticulously by considering the following:
1. HOW MUCH YOU ACTUALLY NEED IN AN EMERGENCY FUND
Think carefully about how much you really need to put into that fund, it might be less than you imagine. Draw up a list of all your outgoings and divide them into necessities and non-essentials. Build a fund that will cover off the necessities.
2. DIVERSIFY YOUR EMERGENCY FUND
If you already have an emergency fund, assess the amount that is in it, consider what you would truly need to cover essentials in the event of an emergency and then look at investing the rest in a low-risk way.
3. OFF-SET AS MUCH COST AS POSSIBLE
Consider trying to offset as much of the costs of having an emergency fund as possible, by looking for the highest yielding savings account with enough access to meet your needs. You will never wipe out the cost and you certainly won’t make up for lost investment opportunities or savings from being debt-free, but this is the best way to manage your emergency fund.
I really hope that my thoughts, ideas and tips on emergency funds help you come to the decision that is right for you.