Rethinking Your Emergency Fund

October 24, 2018

I’ve talked briefly about emergency funds in the past, but now I want to dive deeper into the pros and cons, and how I recommend approaching the subject.

Your emergency fund is traditionally a 3-8 month supply of cash that you have in an account, ready to be used at any given second. Since emergency funds are meant for unexpected expenses or drastic income loss, they need to be accessible fast.

Your car needs a $3,000 fix in order to not explode? Dive into the emergency fund and pay for it.

Suddenly lose your one source of income and need to stay afloat until you find a new job? Thank you emergency fund.

In my opinion, the traditional emergency fund is slowly becoming more and more obsolete. With increasing opportunities to make money anywhere and any way, I do believe their necessity is shrinking. Sure, it is still important to have some extra money set aside for those unexpected expenses -- but do you really need to have 6 months of cash sitting in a savings account? Not really.

Here’s what you do need to have: a checking account with a few thousand dollars in it (to pay bills, ATM, etc), and a high interest rate savings account (for some unexpected expenses and for transferring money to your checking account). The new norm now is around 2% interest rates on most online savings accounts (Ally, PNC, Marcus, Discover, etc). Keep whatever you feel comfortable with in your savings account - I think 3 months of coverage is enough for most people. The thing is, with these accounts your money is losing value. Even at 2%, you’re at best breaking even with inflation. What you ought to do is rethink where you keep your actual emergency fund!

Instead of putting it all into a savings account, think about investing some of it. That way, you can let the money grow with the markets and you can pull it out without much delay if, in the worst case scenario, you desperately need the money. Sure, it will take longer to pull out than a savings account, but almost anything these days can be paid via credit card. And with credit cards, you have about a month or two to pay off the balance before incurring any interest charges. A month is plenty of time to sell some of your investments and gain access to the money.

Here are the reasons why the old-school emergency fund is outdated:

Employment

A reason why I am hesitant to the old 6 month emergency savings rule is this: it’s now easier than ever to make income. Before, losing your job was terrifying because it might take months to apply, interview, and accept a new job offer. These days, any person can make money so easily. I mean, you probably won’t make as much as your previous job, but the income is still coming in and can hopefully support your lifestyle (seriously, if you lose your job, you’re going to have to downgrade your life for a bit until you’re back on your feet anyways). You can drive for Uber or Lyft, do gigs on Fiverr or Upwork, anything you want. Therefore, I really don’t see why anyone would need to burn through 6 months of emergency funds. A dire situation calls for any type of employment, and employment is easy to find these days.

That takes care of the employment reasoning. Find another source of income if you lose your job, and you won’t need as big of an emergency fund to save you!

Credit Cards

Like I mentioned earlier, credit cards can be a life saver. Of course it’s not ideal to put emergency expenses on credit cards and rack up debt -- but it can actually be a wise way to utilize your cards. By putting an expense on a credit card, you’ll have a month or two to pay it off using money from your 1. Stable job 2. Emergency side job or 3. Sold investments. It provides a cushion that may be a relief if the situation calls for it.

Investments

If you’re reading this blog, you’re likely to care about money and therefore have invested at least a little into index funds, stocks, etc. Remember, this is your money to use! It doesn’t have to sit there forever - you can pull it out if needed at any time. The reason why a huge emergency fund is not needed is because you hopefully have investments you could sell off. Start off with selling your non-retirement account money. Then go for the retirement money if really needed (you’ll pay a penalty however).

The more money you have in investments, the less you’ll need for your actual emergency fund. Think of your investments as a secondary emergency fund that you can pull from.

The more money you have in investments at a given time, the more your money is working for you. Especially since most of my readers are young, now is the time to have money in the markets. The earlier you start to invest, the more you’ll take advantage of compound interest. Thank me in 30 years 🙂 Yes, it’s riskier than having money in a bank account. But honestly I think having money losing value in a bank account is the riskiest investment of all!

My own experience

Throughout the last 4 years since I graduated college, I’ve honestly had too much money in the bank. Either I got lazy managing it or putting it in investments, and the proportion of my income that I saved in bank accounts was too high. It’s now much better - I put my money in a good mix of retirement accounts, mutual funds, stocks, business investments, and real estate. I feel more “poor” but my net worth is growing much faster.

Had I started off early putting my money in investments, I’d be a lot better off right now. The market has grown tremendously over the past 4 years, and I missed out on some of that growth by keeping cash in my accounts. I want to share my experience with you so that you don’t make the same mistake I did.

I urge you to take a look at your own financial picture, and see where your money is stored. If you have a stable income and a healthy investment portfolio, you’ll be fine in any emergency. You can pay for an emergency with your investments, or you can easily find a side job if you unexpectedly lose your main job. You’ll need to dial back on a ton of things, but you’ll get through it without the need for such a large emergency fund. Zero income means you aren’t trying at all to stay afloat, and in that case you might not fare so well. I have full confidence that anyone reading this blog can hustle their way to at least a small income in times of trouble!

What do you think about my view on emergency funds? Honestly, it’s still very important the have funds available that you can access. It’s just that the source of these funds does not need to be limited to a savings account if you have other investments going on.

charlie chang the finance habit

Hi, I'm Charlie

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