Why Getting an Emergency Fund While in Debt Ignores the Real Emergency

June 22nd, 2015 by 

Let's not bury the lede on this one: in any actual emergency situation I can imagine (short of losing my credit cards) my first move is to... pay for it with my credit cards.

My opening sentence was way too verbose, but you know I can't stop a blog post there.  Let me go over the reasons why my emergency fund philosophy has evolved to my current position.  And yes, I used to be a fan of the classic emergency fund in a savings account

Let Me Count The Ways...

  • Low Interest Isn't Just Annoying - It's Costly

I'm referring, of course, to the fact that the commonly recommended savings account many folks recommend you use to keep your emergency funds is going to pay you something like 1% interest.  We've discussed this exact phenomenon in the past (with a beautifully hyperbolic title) but the point remains - fighting monetary policy designed to spur investment and spending by saving in the most liquid form imaginable?  It's going to cost you opportunities for greater appreciation.  That was enough for me to shift from my liquidity demands of 2009 (with higher rates!) to my warning to try not to fight the Fed.  (Which, as we now know, will be fighting back soon.)

Oh yeah, and savings accounts are taxed.

  • Airplane evacuation slide.

    Oh no, the cable bill is due?!?!1? * NOT an emergency, sorry *

    You Probably Have More Pressing Issues...

It's a quite a generalization, but the emergency fund issue usually goes hand in hand with the debt zero philosophy we've discussed often on this site.  When people turn to debt zero they, by definition, want to eradicate all debt.

When that debt includes expensive consumer credit like credit cards and payday loans (and yes, money owed to your bookie)... you've already got an emergency.  You're trading earning 1% in interest in the non-zero but non-100% chance of an emergency, when there is a 100% chance you still have that high interest debt.

Remember, emergencies aren't 'planned' or 'common'.  Sure, they have a chance to happen, but your debt already did happen.  That's the emergency!

  • Your Definition of Emergency Needs Work, Anyway

Paying for your car insurance every 6 months?  Getting a tune-up and an oil change?  Property tax bill showed up again around the same date as last year?

If you can see it coming... it's not an emergency.  Period.

A 23 Year old who in her first year on the job, with high deductible health insurance, (even contributing to an HSA - but let's say not full) doesn't have enough to cover the deductible on her health insurance?  When she gets hurt - that's an emergency.

The difference was the 23 Year Old couldn't have seen it coming.  Your car insurance, home insurance, house taxes, whatever?  Yeah, those things go into savings so you're prepared when the bills hit.  Car maintenance can be budgeted for, too - on an older car (read: out of warranty), you're going to be paying a certain amount every year in maintenance... you can budget for that, just put some aside from your paycheck.

So, yes, when your headlight fluid needs refilling, you should have seen that coming.

I'm Not Saying Don't Have Reserves

Of course, I'm not going to tell you to have no reserves at all.  Reaching into my wallet for plastic might be my first move, but make sure you pay yourself back if you do the same - whether it comes out of cash flow or selling securities, or whatever.  When it comes to instant liquidity, the credit cards have that covered and not a savings account with earmarked 'emergency' funds - note our personal credit card strategy.

That means that you need some investments, even if you don't have an earmarked "emergency savings account".  You'd instead have a system where, in case a true emergency happened, you knew in which order you would tap accounts.  (For example, by slowly accumulating IOUs to yourself in an HSA.)

So - there you have it.  Emergencies do happen, they're rarer than many folks make them out to happen, they don't happen 100% of the time and your emergency savings account is an opportunity cost.

Just to be clear, I do have cash - but that's a strategic move.  I also have zero high interest debt.  If you've still got high interest rate debt, that's the emergency.  After that, allocate your resources as you feel is best - just being free from debt is more uncommon than you think.

And now, over to you - what's your philosophy?




PK started DQYDJ in 2009 to research and discuss finance and investing and help answer financial questions. He's expanded DQYDJ to build visualizations, calculators, and interactive tools.

PK lives in New Hampshire with his wife, kids, and dog.

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