Recently I publishing a booklet called “6 Steps To Financial Freedom”.
Buy it here, or send me an email for a FREE pdf version.
The six steps are:
Take Control of Taxation
Leave a Legacy
(I like alliteration can you tell?)
It wasn’t long after I started talking about this before somebody asked me, “what about having an emergency fund?”
It’s a popular belief among financial planners and coaches that after you get your debts under control your next goal should be to save up three to six months of expenses. Most people say to put this money in a readily liquid emergency fund like a savings account. That way life’s little hiccups don’t put you back into debt or cause you to have to take money out of your retirement plan to survive.
This is good common sense advice and if you want to do that go ahead, but I think there are better ways to invest your money than keeping large amounts of liquid cash earning little to no interest for a “rainy day”.
Here are three reasons I do not include having an emergency fund as part of the 6 Steps.
1 – Most so called emergencies are actually events that, if you’re being honest you saw coming and should have been planning for.
The roof on your house didn’t start leaking overnight, a little preventative maintenance along the way and a savings plan to deal with the inevitable will save you the need to dip into an emergency fund at all. If you are out of debt and you see a big expense coming, it’s okay to push pause on the rest of your plan and build up cash for a large one-time expense.But don’t call it an emergency – it isn’t.
Although not technically part of the 6 Steps I call this a sinking fund. You build up money in it over a period of time and then “sink” it when the time comes. Right now I have a sinking fund set up for Christmas Gifts. In December I’ll sink that fund, take the money a buy few gifts. Other common uses for a sinking fund include the purchase a new car, a major home renovation or repair, elective surgery, or even a nice vacation. None of these are emergencies, they are planned events.
2 – A lot of truly unforeseen emergencies can be funded or mitigated through a well thought out insurance program. Some of the biggest unexpected expenses we encounter are the result of disability, illness or damage caused by weather, all insurable risks at relatively low cost. The entire insurance industry is actually one big pool of money designed to help you with emergencies. One way of looking at is as a giant, communal emergency fund. That’s why step two is to regulate risk. If you want to be “self-insured” then you can include some form of emergency fund as part of step 2, but you don’t need a lot and it is not a substitute for adequate insurance.
3 – Finally there are some true emergencies that you can’t see coming and that you can’t insure against. As part of step 3, Rule Retirement I talk about several different investment vehicles that are available for long term planning. Some are very liquid and have no tax consequences for early with drawl. If you are faced with a true emergency, something that can’t be planned for in advance or that you didn’t get insurance for, it’s okay to make a one time with drawl from your retirement funds. Just be aware of the tax implications and be sure to put the money back as quickly as possible.
Here’s the big idea about not having an emergency fund. I firmly believe that by not having a dedicated emergency fund it forces people to change their definition of emergencies. If your emergency fund is too liquid and there are no consequences for taking money out, like incurred taxes or delayed retirement, you may tend to consider everything an emergency. That’s not so say you shouldn’t have some liquid cash on hand, but most people can get by with as little as $1000 or so. If you are out of debt, have adequate insurance and are saving for retirement, there are very few emergencies that you can’t handle in this way.
What’s your opinion of having an emergency fund? How much do you have set aside and where is it held? Have you ever tapped into your emergency fund? If so what for? I’d love to hear your opinion…