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Do You Really Need an Emergency Fund? Maybe Not.

So Many Liquid Assets, So Many Beaches To Enjoy

We all know we’re supposed to have an emergency fund with enough to cover 6-12 months of living expense. We know it’s supposed to be a highly liquid account-either a high-interest savings account or money market fund-something that we can tap immediately if there’s a medical emergency, or if you lose your job, or if your husband loses his job, or if your car dies, or if you decide that you must go to Tahiti-NOW!

My husband and I have such a fund. But I’m thinking about getting rid of it, and you might want to consider it, too.

I know this sounds like blasphemy against the fundamentals of sound financial planning, but here’s what I’m thinking. Six to twelve months of living expenses is a lot of cash. If you have that much money set aside, you could be making a lot more money off of it if you invested it in a more aggressive vehicle rather than a ho-hum savings account making 3% (if you’re lucky).

But is it the right choice for you to put your money cushion where you can’t immediately access it? Ask yourself these questions: If there were truly an emergency, what other resources do you have available? Could your parents help you out in the event of a medical emergency? Would your health insurance cover most of it? If your car died, could you carpool with someone, lease another car, or buy one on a payment plan? Could you (gasp) take the bus? If you’re married or in a committed relationship, could you both live off just one person’s salary if the other person lost his job? If not, are there expenses you could give up (like cable or eating out) if you really had to that could allow you to live on one salary? Could you crash on a friend’s couch? If you couldn’t cover the rent/mortgage for some reason, could you move to a cheaper apartment or rent your home?

I guess the key takeaway here is that there are other kinds of financial cushions besides thousands of dollars in a bank account. There are cushions you can build into your life by knowing what you can live without and who you can turn to, and by planning for emergency situations beforehand by buying the right insurance (medical, life, auto, homeowners/renters, long- and short-term disability, umbrella). If you are already used to maxing out retirement contributions (401K and IRA) each month, that’s more than $1500 extra that you could divert to personal use if you really needed it (without withdrawing from your existing retirement accounts-just stop contributing for a few months). Plus, if you choose to put your money in a high-yield taxable account instead of a safe but lower-yielding money market fund, you could always withdraw that money and just deal with the capital gains tax. After all, the whole point of an emergency is that is it something that is highly unlikely to happen, but when it does, it takes higher priority over other things (like tax sheltering).

My issue is, if I have the emergency fund just sitting around in my bank account, chances are I will use it to go to Tahiti-instead of for a real emergency.

Post Your Comments

Has anyone out there ever benefited from an emergency fund or known someone else who did?

What was the most drastic lifestyle change you’ve had to make to deal with a financial emergency?