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Wednesday, January 30, 2013

Cash Emergency Fund - Yea or nay?

There is some debate in the personal finance community about the use and utility of emergency funds.

Some people advocate not even having a dedicated emergency fund, and argue instead for relying on various lines of credit for actual emergencies (credit cards, HELOCs, etc). Their arguments are usually that the the need to use emergency funds are mercifully rare, so it's better to have that money working for you in the meantime. And in the event that you do have to use a line of credit, it is available right away, and you can then sell off some stocks or other assets to pay it off but in the meantime that money was at least earning you interest.

If we are talking about somebody with $50k or $100k worth of savings sitting in a band account earning a quarter of a percent, then they are definitely right. While I understand the feeling of security that comes from having that much money on hand, there is no reason to have that kind of earning potential just sitting on the sidelines. Especially since, in the event of a real emergency, you could liquidate most assets in a matter of days or a week or two if you really needed a lot of cash, and having a charge on a credit card or HELOC for a short amount of time like that isn't a big deal.

Where I disagree is with small, actual cash emergency funds.  One of my interests / hobbies is preparedness, and I think there are a lot of good reasons why everybody should have anywhere from $500 to $2000 on hand in actual, physical cash. The supposed interest you would be missing out on is minimal on an amount that small, and the risk of losing it to fire or burglary is also overblown by most people. If you put it in a safe secure spot, it is very unlikely that you would lose that money, even in the event of a burglary. And there are plenty of reasons to have actual cash on hand.

In many times of emergency or disaster, a lot of businesses will only accept cash. In today's technological climate, if there is any economic turbulence, electronic banking /atms are usually the first thing to get disrupted. These problems are usually short-lived, but not being able to buy anything for a week or more could be problematic, so it is useful to have cash on hand.

Having cash is also great for good opportunities, not just disasters. If you are a reseller, picker, or just have an entrepreneurial spirit in general, having cash on hand can allow you to take advantage of a lot of opportunities quickly.

Remember this applies to relatively small amounts of money. I am not suggesting you keep $20K in cash in your house, but having $1000 or so in cash in your possession maximizes the benefits while reducing the downsides to the point of being almost negligible.

For a larger emergency fund I would follow the advice I outlined above: have a line of credit that can be accessed quickly and is equal to 6 months or so of expenses, and don't use it unless you have assets to back it. Then you can use the credit to deal with the expense right away, and pay it off in a few days/weeks when you have liquidated assets (where the rest of your money should be, to make you money).

-The Money Monk

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