Emergency funds are a highly debated topic amongst the financial community and one that shouldn’t be taken lightly. So where should you stand on the matter?
I personally feel that having an emergency fund set aside for a disaster is important, especially if you have dependents, but I disagree with where this money should be kept.
So let’s start from the beginning and break it down so you can come to your own conclusion based on your unique circumstances.
So what is an Emergency Fund?
An emergency fund is liquid cash being available to use in case of a financial emergency such as home/car repairs, medical bills, or a period of unemployment. This fund is then used to cover these expenses to prevent going into excessive debt.
On average, the recommended emergency fund is any where from 3-6 months of your average monthly expenses saved up. With some saying as much as 8-12 months saved.
For example if you or your family spend $4,000 per month, according to most, a safe emergency fund would be $12,000-$24,000 saved up in liquid cash. Meaning, cash that you have quick access to such as money in your bank account.
Do most people have Emergency Funds?
In America, it’s reported that roughly 57 million Americans do not have an emergency fund started at all. With 47% of millenials and 42% of baby boomers having < 3 months of expenses saved up.
According to a survey from Bankrate’s latest financial security index survey, only 39% of people reported that they couldn’t pay for a $1000 dollar emergency from their savings…
Although, the year by year research is showing an increase in those utilizing emergency funds in their financial planning. A definite step in the right direction for financial literacy.
YES, you NEED an Emergency Fund!
I know it’s easy to think that nothing will ever go wrong for you, especially if you have strung together a series of fortunate years in a row. But, according to the same Bankrate study, roughly 1/3 of all households had at least 1 unexpected emergency expense that year with over half of those emergencies costing over $2,500
As shown, life, does in fact happen sometimes. Even with the best planning, there may be situations or poor timing that occurs that does leave you financially exposed. Hopefully these are minimal, but they do in fact occur.
For me, just this past weekend, I went in for a routine oil change. A $20 dollar charge, no big deal. But when they were looking over my car while it was raised up, they found that metal wires were exposed on the inside of both my back tires.
Meaning my tires were at risk to have a blowout and with how much I currently drive, this was extremely dangerous. Looking at the car from the ground and you would have never known anything was wrong.
The point of the story, is that my routine oil change ended up in me spending quite a bit more at a tire store later that day. Had I not been financially prepared for this type of charge I could have been in big trouble.
At the end of the day, life decisions (especially the financial ones) are all about managing ones risk. But even when we manage risk, that doesn’t guarantee us that we won’t have unexpected charges a la my tire situation. Which in reality is very low on the emergency list.
For many of you, the peace of mind of knowing that you and your family will be safe and covered in case the worst happens is enough to consider an emergency fund.
If you are someone who needs this extra peace of mind, then the answer for you is without a doubt a yes. Or if not having an emergency fund is something that will keep you up at night, then for your sanity alone, it is worth starting this fund immediately. I will never argue with this reasoning.
NO, you don’t NEED an Emergency Fund!
This might be a poor heading because it’s hard for me to argue against not needing an emergency fund altogether because life happens even for the single, healthy, 20-something year old just entering the work force.
It’s more a matter of arguing that you do not need an emergency fund in the traditional sense which is holding your emergency fund in your checking account like the majority of people do.
So where should I keep my Emergency Fund?
Most people hold their emergency fund in their checking or savings account which returns 0% and around .01%, respectively. Even a high yield savings account like the ones offered at Ally and Synchrony is only around 2.2% return. So this emergency fund is offering the peace of mind, but it is not allowing your money to work very hard for you. And to me this feels like wasting money and opportunity.
So why not instead, invest your emergency fund in the safety of low cost index funds. This will allow your emergency fund to grow by the average 8-10% annually while still serving as your back up reserve in case the worst happens.
For example, a $12,000 emergency fund in your typical Wells Fargo .01% savings account would grow to a whopping $12,012 after 10 years. Where as the same $12,000 invested into a low cost index fund with an average return to 8% would return $25,907 over the same 10 years.
You have now doubled your money, you still have your emergency fund, and you have more money to compound for future returns.
But I won’t be able to access this money!
Yes, this is partly true if you are investing your emergency fund in your 401k, Roth IRA, or traditional IRA as these have rules regarding withdrawal.
However, even these accounts have hardship withdrawals which allow you access to your money before the required time frame. It would just cost you a fee, which is normally around 10% along with needing to pay taxes on your newly acquired income or earnings.
This likely is still more of a return on your money than letting your emergency fund sit in your savings account depending on the timing of the emergency.
Regardless, I still don’t recommend this strategy.
There has to be a better way!?
There is. A brokerage account. I store nearly 100% of my emergency fund within this account. I keep roughly $1,000 in my checking account for everyday/weekly purchases and $1000 in my savings account to act as a buffer on my investment schedule every pay period.
A brokerage account is a post-tax investment vehicle, so any contributions are yours, you’ll only have to pay tax on the earnings of the particular stock you are selling to fund your emergency expense.
It does take roughly 2 days before this cash is liquid, so if this emergency is in need of rapid money. I suggest using a credit card to bridge to time until you have access to the money from your brokerage account.
Regardless I would put the expense on my credit card to continue to work towards reward bonuses for travel. If I’m getting screwed on some unexpected expense, I’m at least going to use it to fund my next vacation.
However, do not mistake my words and think that a credit card IS a financial emergency strategy. Because it isn’t. Credit card debt can sink you just as fast as an unexpected financial emergency.
It’s strictly a strategy for access to quick money, before quickly paying off your credit card balance with the funds you receive from the withdrawal from your brokerage account.
One more Strategy: An HSA or Health Savings Account
This is an extremely powerful tool which I explore thoroughly in this past post here. But briefly, an HSA is an investment vehicle that allows you to invest tax-free, grow your money tax-free and then withdraw your money tax-free for any medical costs. Sweet, right?
So in terms of medical emergencies, this can be a great tool to help tip the scale in the risk vs peace of mind debate on emergency funds.
Conclusion
I fully support the idea of everyone having some form of an emergency fund. And I definitely recommend the idea of holding your emergency fund in a brokerage account.
This allows you to take advantage of compound interest and make your money work for you. It also makes it so you don’t need to calculate an exact amount of monthly expenses you need to save up. Because, if you consistently invest, the money in this account will consistently be growing from your contributions and your return on investment.
However, at the end of the day it’s all about your own peace of mind and your families best interest. So for you, if having your money under your mattress or in a savings account works for you and helps you sleep at night, then that is the best option.
Do you have an emergency fund? If so, where do you hold it?
As always, comment below with any questions or concerns. Or if you have any specific questions for me, please feel free to message me directly here!
