I read quite a few personal finance blogs and a lot of them talk about putting aside a few months expenses in a savings account as an emergency fund.
Well if you’re carrying any debt, then I think Emergency Funds Are Bullshit.
Let’s look at some basic math. (I’ve based this on Australian rates and circumstances, it’s what I know)
In my case I’ve got around $20,000 in credit card debt. Based on my current interest rates I’m paying around $3,400 a year in interest, now if I was to have about three months basic expenses put aside as an emergency fund in a savings account, I’d have around $6,000 sitting there. Over a year in a 5.5% return savings account I’d earn around $330 a year in interest. However as my government has decreed, Interest I earn is assessable income. So at my current marginal tax rate I’d lose 30% of that in tax giving me a net return of $231 for the year. Have I lost anyone yet ?
Now if I used that same $6,000 to offset my credit card debt I’d be reducing my interest bill by $1, 020. If you take away the $231 net return from my theoretical “Emergency Fund” It would actually cost me $789 a year to be carrying that money for a “what if” situation.
Now on my wage I think I could actually purchase an income protection insurance policy that would pay out more than two years of my wages for less than that. (I’ve sent in the online quote form and I’m awaiting a response.)
UPDATE: The most expensive quote I received was less than $360 a year for 75% of my normal wage and the premium is also deductable against my tax so take 30% off that amount again.!
Let’s look at another example, Say you have a $200,000 mortgage at 7.5% over 25 years. According to Bankrate over the term of the loan you’d spend $243,394 in interest payments. Now let’s say you offset that loan by the theoretical $6,000 you’d set aside for your “Emergency Fund.”
If you maintained the same repayments as for a $200,000 mortage you’d cut 2 years off your mortgage payments, pay only $213,480 in interest and save a massive $29,914 in interest, which over a 25 period works out to a massive saving of $1196 a year saving. After you take into account the interest you’d recieve on having a savings account for your “Emergency Fund” you’re still infront to the tune of $965 a year.
Just take a moment to think what you’d have to do to earn an extra $965 a year.
If you think I’m making this up run the figures through Bankrate yourself.
Now I’ll admit I’m no financial guru, read my site and you’ll see that, but you can’t ignore the basic maths. Who ever came up with the concept of an Emergency Fund must have been working for the lenders.
I’m not arguing that everyone should have some funds set aside for unexpected events that place a strain on your financial resources. But to say you need to set that money aside in a savings account for a rainy day is financial negligence.
If you’ve got credit card debt, then make sure you have sufficient a credit limit to cover emergencies. If you’re carrying a mortgage then make sure the extra funds are set up into some sort of offset account so you can access the funds at short notice.
I’ve just looked at a couple of common situations for my part of the world. Do the maths for your own situation and work out for yourself if sitting “Emergency Funds” in a savings account is the right thing for you.
For me it’s just Bullshit.
September 16th, 2005 at 3:47 am
All fine and good, but what do you do when an emergency comes up? Pull out the credit cards? Not a good strategy.
September 17th, 2005 at 7:35 am
Hmm, I’ve noticed that your debt balance seems to GO UP every month. While I am sure that you have “good” reasons for not having an emergency fund, using your credit card to finance your “emergencies” is not a good idea. In fact, if you are out of debt, on a budget, and planning for future expenses, then you don’t NEED an emergency fund, but only because you will have all of your various future emergencies “funded” on your budget sheet.
September 17th, 2005 at 12:52 pm
I noticed the same thing as ncnblog. You seem to want to do something about your debt but you
keep using your cards, and your balance rises. Good intentions are just that, usually don’t
help pay down cc debt. As for the EF issue, I think any person with any financial sense at all
has at LEAST $1k put away in case of an emergency, or has that goal. You just did all this math, and no,
and considering your debt, it doesn’t make sense to have a large EF, but something, yes. Have
you done the calculations to figure out how much longer it will take you to dig out when you
keep using your cards?
September 17th, 2005 at 3:52 pm
Hey Broke, ncnblog posted on “snowball debt reduction” recently. You may want to check it out.
September 18th, 2005 at 11:10 pm
[…] okay, it will all work out in the wash. I’m going to respond to the comments on my Emergency Fund post in the near future. I’ve submitted it to the Carnival […]
September 20th, 2005 at 12:07 am
[…] y, we’d all be debt-free. “Broke” of Credit Card Victim talks about how Emergency Funds are BS. (Warning: BS is spelled out in the post.) It looks lik […]
September 21st, 2005 at 6:45 am
I think the concept of the emergency fund is primarily psychological. You yourself posted recently “I think I have about $300 in my everyday account … I shouldn’t need the extra cash until next payday, but I’m always wary of not having that little bit of backup.” So even though you say emergency funds are BS, you’re ‘wary’ about not having a little bit of backup.
For people who take things possibly a bit more seriously than you do (don’t know you except through this site, so I don’t know how serious you are about getting out of debt), having money for a week or two isn’t enough, especially when you’ve got family, payments, etc, to consider. Having that peace of mind that you’re not 3 days from being out on the street is priceless for many. Yes, it might cost $29k over a 30 year mortgage, but people who are really concerned about that long term picture will find other ways of paying it off early without dipping in to the emergency fund.
September 22nd, 2005 at 2:02 am
I agree that emergency funds are BS if you are already in debt. Would it be smart to borrow $2000 on a credit card to just “have around” in case there was an actual emergency? Of course not. But that’s what you are essentially doing if you have $2000 available that you are not immediately applying to an existing debt.
IMHO an “emergency fund” should be at most a couple hundred in cash in case a disaster cuts off ATM/CC access.
An emergency fund exists so you WON’T GO INTO DEBT if there is a sudden financial emergency. If you are already in debt, an emergency fund helps you not at all!
The bottom line is, if you are in debt, having an emergency fund will keep you in debt longer, and increase the total finance charges you pay. Not smart.