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A while back I wrote a post about deciding how much money to put towards your emergency fund. Here’s the first line I wrote:
Everybody with basic financial knowledge knows the importance of an emergency fund. Just look, here, here, and here
Here’s the funny thing, I truly thought it was a no-brainer. However, a couple days ago I stumbled on this article written by Liz Weston on having a $0 emergency fund. Needless to say I was quite interested in what she had to say on the topic. Let’s see how realistic it is to have a $0 emergency fund.
Liz Argues Flexibility is King
In the beginning of the article Liz makes a very bold statement of how the traditional emergency fund needs to be rethought. Here’s what she said:
The whole idea that everyone needs a big pile of cash, and needs it right now, should be rethought. In reality, the failure to have a fat emergency fund isn’t inevitably a crisis. At the same time, those who feel safe because they have three or even six months’ expenses saved up might be kidding themselves.
What really counts is your overall financial flexibility — the resources you can command to help you withstand a crisis, even one that’s unexpectedly severe or long-lasting.
She’s essentially making two main points. First, having 3-6 months worth of saved expenses may not be enough. Second, Flexibility is really the most important thing. The first point does not hold very much water. It’s true that emergencies may last longer than you expect and you may run out of cash savings, but you should still prepare.
The idea of having flexibility during a crisis is interesting. Liz’s argument is to use credit as a tool to help out during an emergency. She mentions two different sources, home equity line of credit (HELOC) and credit cards. It’s true that you could leverage your credit to save yourself in a pinch. Here’s where I disagree with her argument. Flexibility does not replace preparation.
Have Your Cake and Eat It Too
I will definitely admit that it’s difficult to grow an emergency fund. Since I am actively working on my student loan debt, I’m only putting away a couple hundred dollars a month. To reach my target goal of 9 months worth of expenses it may take me years. But the day that I need that emergency fund I know that I will be thankful that I was working towards it all along.
Just because something is difficult and takes a long time, doesn’t mean that it isn’t worthwhile, and I think that’s the fundamental problem with her argument. That’s almost like saying, saving up enough money to retire takes a long time, so I’m not going to save at all (okay it’s not really that bad but hopefully you get the point).
Here’s what I liked: the article pushes the reader to think about other options. What are the other things you can do in a pinch? This point is gold. When we think too traditionally, we can forget some of the other resources available. Building a traditional emergency fund and being flexible in the event of an emergency are not mutually exclusive. Have your cake and eat it too.
Peace of Mind
I stated this in my previous article about emergency funds. What really matters in the end is peace of mind. Liz’s first point does have merit, insofar as you shouldn’t lure yourself into a false sense of security. But with any emergency the best thing you can do is to prepare. One way to prepare is to try to save enough for the emergency. A second way to prepare is to understand your options. This goes back to Liz’s second point of flexibility. Whatever you decide to do in the end, just make sure that you’re comfortable with it. Personal finance isn’t always about the math. For some people knowing that they have credit to outlast a storm may be enough. For me, having a large pile of cash, even if it’s not earning me much, will help me sleep better at night.
What are your thoughts?
(Photo credit: dumbledad)
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{ 4 comments… read them below or add one }
I think the sleep well at night factor makes it important – for me, anyway – to keep a specific, stand-alone cash reserve for “emergencies”. These issues have a habit of emerging when least expected, despite the best plans. Job loss, accidents, illnesses, and things of the like do happen to people. It’s remarkable to me how many folks are shocked by such occurrences and are financially unprepared since they don’t factor these things into their budgets. Things happen. That’s why I like a separate, stand alone cash reserve of at least 9 months of expenses.
Now. once retired, I think it’s questionable to have an “emergency fund”. From my way of seeing it, retirement planning should account for such problems such as major health expenses. They aren’t exactly unlikely to happen. If one isn’t working, then loss of regular income stream should, hopefully, be less of a risk – if planned effectively.
Of course given that I’m far from retirement age, there might be some factors I may not be thinking of. I’ll concede that.
But, back to the concept of emergency fund for working folks, I think it’s an important tool – if nothing else for behavioral and psychological reasons.
Personally a $0 emergency fund is not a viable option for me. I believe cash is king and recommend having a funded emergency fund. If there’s one thing people have learned during the recent credit crunch is that you cannot solely depend on your credit line.
Credit card accounts/lines of credit can be closed and reduced, which can put an end to the flexibility argument. Plus, given the state of the housing market – the chances of having a HELOC are smaller.
When you plan ahead and save for unexpected emergencies you are in a better position financially, than if you solely relied on your creditor as your backup plan. As a last resort, having the flexibility to use credit definitely helps if your expense outweighs your emergency fund.
@KP – I definitely agree. Nothing beats cash. It’s a great idea to know that you can use your credit if you need to but to rely on them exclusively seems irresponsible. I think you make a great point about credit being closed or reduced as well. Well said!
@Squirrelers, you’re definitely right about the sleep factor. That’s one of the reasons why I continue to work towards building my emergency fund. I haven’t really considered the state of the emergency fund once retired, most likely because I’m so far away. But you raise an interesting point about the worry of job loss being much smaller.