Most of us have heard of an emergency fund; a fund to help us should we get sick, injured or fired, or some other way loose our job. But is it really necessary these days? There are some who say they are essential, and others that say, not so much. Lets look at the issue more closely and then you decide. There are a few factors that you should consider in deciding if an emergency fund is the right tool for you to use.
You will be hard pressed to find any financial planner who does not recommend an emergency fund, they are considered the backbone of sound financial planning. So important that you could even talk yourself out of using yours downplaying the emergency at hand, and never touching it. But you must look at your unique situation because everyone has different goals. Look at the following issues.
- Financially Responsible People
- Credit Cards
- Unemployment Benefits
- Opportunity Cost
FINANCIALLY RESPONSIBLE PEOPLE
Most financially responsible people do not need an emergency fund because they may already live below their means, and have access to credit. Now assuming that the financially responsible person also has really good credit, they presumably have access to money easier, and are able to tap into that source when and if needed during an emergency time period, such as illness, or loss of work. Keep in mind that if you are not working you will have less expenses in other areas, such as travel costs or other work related expenses. The financially responsible will be apt to cut more expenses out and be able to survive on less.
Credit cards can be a way to bridge the gap in an emergency, and then paid down over time once the financial emergency is traversed. The average credit card rate in America is 14.89% according to CreditCards.com and investing your emergency fund, will probably not get you a 15% return, so you will be losing money. If you use credit cards wisely, you do not need an emergency fund.
Depending on what state you live in, how much time you have on the job and other factors you could receive about 75% of your wages should you loose your job, or become injured and a have to take time off. Check Servicelocator.com to see what your state offers. Regardless, if you are entitled to unemployment of any amount, your need for an emergency fund goes down because you will only need to account for a small percentage of earning being missed, and not the full amount of lost earnings.
Rather than setting aside money for your emergency fund, why not invest a small amount in an insurance policy or medical coverage policy. Short term disability insurance can kick in if it is a work related injury. Some of these policies can be as low as $39 a month. Using insurance as a planning tool can greatly reduce your need for an emergency fund and free up that money to do other things for you.
Most employers will offer insurance coverage benefits. They may be fully paid by the company, or funded by you through a deduction in your pay check, and considering that most of these types of policies are for large groups the cost of the policy out of pocket for you may be mere pennies. A good financial planner should be able to assist you in finding a good policy and coverage that fit your needs.
What is opportunity cost? It is generally speaking, the value given up to get something else. Sitting on a large pile of money will earn you nothing at all, zero in interest, if you have it stuffed in your mattress. Most bank accounts, if that is where you have your money resting, do not pay any interest on the account, or very little, less than 1%, where the average investment rate of return is about 8%. Here the opportunity cost is evident. Easy example, $10,000 cash sitting around in a bank account will earn you $100 in interest for a year, while at an average return of 8% will get you $800, that is $700 more dollars in your pocket. Which amount would you rather have?
So in sum, with all the available investment tools out there, the ease of online tracking, deposits and withdrawals you have no need for an emergency fund these days. It is just to great a loss in potential interest and income to have your money laying dormant and not working for you. With all the alternatives mentioned above you can have the piece of mind that in the event of an emergency, you will have your bases covered.