Why The Traditional “Emergency Fund” Is A Bad Idea

Now I am sure that I’m going to get a lot of heat for this one, so just let me say that if you do have an emergency fund, that is great, but you are only halfway there. In general, people start an emergency fund to set aside the funds needed in the event of a personal financial dilemma, such as the loss of a job, a debilitating illness or a major unforeseen expense. 

In other words, for an EMERGENCY.

Putting money in a savings account is not quite the same thing. Savings generally have a purpose, while an emergency account is meant to help you out in difficult times when you really need the money. This way you don’t need to make early withdrawals from your retirement accounts just to feed yourself or make ends meet.

When it comes to a real emergency, liquidity is not that important. You can get the money easily, but you don’t need to do something as simple as reaching under your mattress to get it. This is why I don’t think emergency funds, in the traditional sense, are being proposed to people properly. If you are one of those folks who has an emergency account, good for you! But if you are in the process of starting one this year, here are some things to remember:

1) Cash does not grow.

Setting aside physical cash in a savings account or under your mattress may guarantee that you’ll have liquidity when you need it, but the same amount you put away today will be the same amount in the future and will be worth less thanks to inflation. Simple laws of time value of money should tell you that a dollar today is worth more than a dollar in the future and unless you have a way to combat inflation, you’ll actually end up with less money when you really need it.  

2) Emergencies are not expected to happen all the time.

If this is the case, put all your money in a savings account and use it accordingly. However, if you have tons of cash in a savings account and you’ve been sitting around waiting to get sick or lose your job in order to use those funds, it’s really sad how much interest you missed out on.