Emergency Funds are Overrated
The most common piece of financial advice is to have an emergency fund. More specifically you’ll probably be told to have a three to six month emergency fund. There is nothing wrong with this advice but there are some who advocate a much larger fund such as nine months or even a year of expenses as an emergency fund. This is ridiculous.
Who Is This Advice For?
The common e-fund advice is for those of us who are just beginning our financial journeys or who haven’t gotten a strong enough grasp on our finances to move beyond this. For some, unfortunately, they never move beyond this level of financial sophistication. Others, however, do graduate and yet still heed this advice even though it really isn’t necessary any more.
What Is An Emergency?
When asked this question people will often say things like an unexpected car repair, or house repair, or maybe an illness. All of those are somewhat legitimate but when pressed further for an example of an unexpected car repair, for instance, they’ll say, break replacement.
That is not an emergency! That is an expected repair that comes as your car ages. Similarly, most home repairs are not emergencies. I once had a bathtub that had a bad seal and leaked onto the ceiling of the floor below. I did not however, run to my emergency fund. I got the tub repaired out of my monthly savings/cash flow and I lived with the stain for a while eventually repairing it when I could.
So what is an emergency? Well, if, during a thunderstorm a bolt of lightning hits a tree in my yard causing a branch to pierce my roof, that would be an emergency. But guess what? I have insurance. So yes, I may have to put out some money at first but, the insurance company will pay for the repair minus any deductible, which would come from my emergency fund.
The Big One
The big reason, the main reason for an emergency fund is if you lose your job. You have to continue to pay for your rent or mortgage, your car payment, your utilities, gym membership, monthly massages, dinner out and many other things as well. But wait — you don’t have to continue, you should NOT continue spending money like you did when you had a job if you lose your job.
The best course of action when a major event like a job loss occurs is to modify your behavior. You will get much more benefit than simply raiding your emergency fund. It’s why I keep cars long beyond the time I’ve paid them off. So that a car payment isn’t a drag on my finances every year.
A Strong Financial Base
An emergency fund becomes less important the stronger your financial base becomes. If you’re handling your finances correctly you should have money left over every month even after savings, this is called being cash flow positive.
If you’re using credit cards (and I believe you should) and, this is important, paying them off every month, then you have an emergency fund without having piles of cash doing nothing but waiting.
I can anticipate the backlash that people will say I’m advocating credit card debt for emergencies but, no, I still expect you’re able to pay it off in full when the bill comes due. It’s just that you have time to do other things like modify your behavior by maybe skipping a dinner out this month or delaying another purchase you were planning, as just a couple of options.
A Small Emergency Fund
Once you’re in a stable financial situation, I’d say you only need a three month or so emergency fund as you now have more options. But like any other financial aspect of your life, you need to reassess as time goes on.
If layoffs are rumored at work, I’d probably increase my emergency fund, start cutting spending sooner rather than later, and delay some purchases. It’s called being proactive and that is your best hedge against emergencies.