Google the term “emergency fund” and you might find yourself torn between clickbait like:
- “Why you Absolutely Need an Emergency Fund.”
- “Why Emergency Funds are a Bad Idea.”
- “Money Advice the Experts Don’t Agree On: Emergency Funds.”
Confused? That’s understandable.
An emergency fund is a financial safety blanket. It’s the chunk of money you hide away just in case something goes terribly wrong.
It’s nothing new. The phrase has been around for centuries. In fact, according to Google’s Ngram, the term “emergency fund” was first spotted in 1797. Frequency of use peaked in 1942, then dropped to a post-peak low in 1965.
As a general rule of thumb:
- Your emergency fund should be worth 3-6 months of living expenses
- It should be kept in a cash account
- It should only be used for emergencies
So, what’s behind the debate?
The Catch 22 of Emergency Funds
Catch 22 is one of the most misused terms in the English language. It was originally coined in Joseph Heller’s novel under the same name. It describes “a paradox in which the attempt to escape makes escape impossible.” In really simple terms, you’re doomed if you do and you’re doomed if you don’t.
As shown by the clickbait titles listed above, emergency funds sit under a similar umbrella.
For life’s unexpected turns, an emergency fund might be your best insurance. But, there might be “far better places to put your money than an inert account that can’t enrich you.”
“Why you Absolutely Need an Emergency Fund”
It’s safe to say that anything can happen. There’s a reason the phrase “expect the unexpected” is used so often. Walking through life without an emergency fund might feel like walking a tightrope. Without a financial safety net, you might find yourself with nothing to fall back on. In an article published on Investopedia, Amy Fontinelle writes, “An emergency fund is the best kind of insurance you can have to cover many of life’s unexpected expenses.”
And life has a knack for throwing curveballs. From surprise bills to sudden accidents, from emergency maintenance to periods of unemployment. Without venturing too far into the worrying list of possibilities, it’s a pretty dismal picture. Your emergency fund might help to keep you afloat, just in case you find yourself treading water.
Emergency funds are often kept in cash. As an asset class, cash is liquid. It’s readily accessible to you. By keeping your emergency fund in an instant-access bank account, you’ll be able to dip into it the moment you need it most. Like a life jacket that inflates the second you pull on the toggle.
“Why Emergency Funds are a Bad Idea”
It’s odd to assume a safety net is a bad idea. But emergency funds attract a lot of scepticism. According to Greg McFarlane on Investopedia, “common advice to create an emergency fund is overly prudent.”
Let’s assume you adopted the first rule of thumb: your emergency fund should cover 3-6 months’ of living expenses. How easily can you save 3-months’ worth of outgoings? If your monthly costs totalled £1,200 and you could only afford to save £50 a month, it would take you 6 years to reach a 3-month total of £3,600.
The act of saving is where the catch 22 comes into play. By storing a lump sum of money in a cash-based account, you might not be creating wealth, you might be watching it “methodically diminish.” Why? Chances are, in the battle against inflation, cash won’t come out on top. At the end of the day, “an emergency fund is a money-losing proposition over the long term.”
“Money Advice the Experts Don’t Agree On: Emergency Funds”
As it turns out, hardly anyone can agree on the small print. A 6 months’ cover could be far too cautious, yet some say eight months is about right. However, there are those that think you should prioritise clearing any debt first or that you should prioritise building your emergency fund whilst only making the minimum due on your credit card payments. In fact, some think you might not even need an emergency fund at all.
What you use it for can vary too. Let’s say your emergency fund is neatly stashed away in a safe place. Somewhere along the line, your car starts to feel a bit sluggish. You decide to replace it with something more reliable. Does that warrant dipping into your emergency fund?
Monevator lists paying for a flight to a relative’s wedding as one reason you might need an emergency fund. But Investopedia argues that buying a plane ticket for a job interview isn’t an emergency, it’s “merely life.”
Finding a Middle Ground
Ultimately, your approach to an emergency fund should be your own decision.
It’s unlikely that over-saving is a bad thing. But if you want to give some of your money the chance to grow, or potentially reach a savings goal faster, you could invest your money. And if you can’t afford to part ways with too much cash, you really don’t have to.
On our platform, for example, you can invest in any of our investment opportunities from just £10. Any rental income you may earn will be deposited into your electronic e-wallet, on a monthly basis. You can choose to withdraw this, or reinvest it. The choice is entirely yours.
Written by Jenna Kamal
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