You're A Sucker To… Have A Big Emergency Fund

February 26th, 2010 by financialuproar

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This is the second post of a Friday series called “You’re a sucker to….” which explores whether conventional financial wisdom is necessarily the best advice out there. Everyone’s situation is different; if you’re doing something that I tell you you’re a sucker to do, it doesn’t mean it’s bad or wrong. There’s just other options out there that you should be aware about. You can read the first of the series here.

An emergency fund, when used properly, can be one of the best financial moves you can make. Having supplemental cash on hand can be used for anything from car repairs to a broken furnace to vet bills for a beloved pet. If someone doesn’t have a sum of cash, they run the risk of getting into a problem if the you know what hits the fans. If there’s a money emergency, someone who has just gotten out of debt could fall right back into the abyss. Nobody wants that.

It’s not the idea of an emergency fund I have a problem with. My problem is with the size that people recommend. The Simple Dollar recommends a person have 6-12 months of cash sitting in an emergency fund. Frugal Dad recommends the same. For the average family, this represents having anywhere from $25k to $75k sitting in a bank account earning 1% interest. Financially, that’s a very bad move.

There’s no reason why you can’t take the money you’d normally have in an emergency fund and have it as the more conservative part of your portfolio. Buy an exchange traded fund of real return government bonds. Or maybe some high grade corporates. Mix in some preferred shares as well. If you bought a combination of the three, you’d be getting close to a 4% return. That sure beats 1% from your savings account. 3% more on $50k is $1500 per year. The prices of these three funds don’t move very much either. They basically have a 10% range. If you’re forced to sell something at a loss, it won’t be that big of a loss. Take the amount of risk you’re comfortable with.

Don’t put all of your money in something like this. I’d like you to have a month’s worth of expenses sitting in your bank account. Emergencies happen. But what kind of emergency really needs more than one month’s expenses to fix? How likely is the probability that sort of catastrophic event to happen? It’s like winning the crap lottery. Sure, it happens. It just isn’t very likely.

Having money sitting around doing nothing is a financial sin, plain and simple. I never have more than $5k in liquid savings. My money is constantly being put to work. It begs for a return greater than 1%. And yeah, emergencies happen. I have a credit card available for just that purpose. I simply charge up my credit card, then take my time figuring out how I’m going to pay for it. Why have piles of money kicking around when there’s credit cards waiting to lend you the money? I can sell all or some of a position in an ETF in 5 minutes and still have enough time to twitter everyone about what I did. It takes 3 business days for the money to be accessible in my account. That’s it.

It’s about time for people to put that emergency fund to work. Your increased net worth will thank you.