Financial gurus recommend keeping 3 to 6 months of living expenses, if not more, available in an emergency fund for life's unexpected expenses. But, there is rarely a one-size-fits-all solution for personal finance problems, and it is quite possible that saving in an emergency fund is not the answer to every unique financial situation. Is it possible that trying to save for your emergency fund is actually the cause of some of your financial emergencies?
Where's the fire?
What exactly is everyone saving money in an “emergency fund” for, and how often are people experiencing these financial emergencies? Pew Research follows social and demographic trends, and discovered that about one third of adults say they had a financial emergency or unexpected expense that set them back considerably.
Medical reasons were the most common, with 34% of people reporting a medical financial emergency. Car problems were a problem for 24% of those surveyed, and housing-related financial emergencies were reported by 20%.
Probably more important than the type of emergency is how it's financially impacting families. While experts have suggested that everyone should be saving 3 to 6 months of living expenses in an easily accessible account -- the average cost of unexpected expenses annually is about $2,000 per household, according to the Consumer Federation of America.
According to this research, the chance of an emergency is about 34% with an average cost of $2,000. So why are we trying to save $9,000 to $18,000 (based on living expenses of $3,000 per month) in an emergency fund? And while we’re trying to build up this fund, are we missing out on opportunities to make more money or pay off high interest debts?
When emergency funds take the backseat
It does not always make sense to keep saving money in a savings account that isn’t earning a very good return. In fact, there are several situations when you really should avoid saving to an emergency fund in order to help minimize your risks of causing financial emergencies!
High interest credit card debt. If you are attacking your emergency fund with as much as you can afford to save each month and only sending the minimum payments on high interest credit card debt, you’re just creating a new expense for yourself. High interest credit card balances will continue to accumulate month after month, and the small return you earn in a savings account is not going to come close to balancing the score. Concentrate on paying off high interest debts before building an emergency fund.
You have investments. Popular opinion leads many of us to panic over not having enough money for the unexpected expense that might come up. Is it possible you already have an "emergency fund" but you just didn’t label it as such? If you have investments that you can withdraw money without penalty (or even with a low penalty), you essentially already have an emergency fund. Chances are your investments are earning a higher interest rate than a savings account, which means your emergency fund continues to make you money when it’s not being used!
You're free of debt. If you’ve been living within your means and currently have no debt and fairly low living expenses, you probably don’t need to stress about an emergency fund as much as someone with high living expenses and extensive debt. If you are faced with an emergency and don’t have enough in easily accessible savings, you are likely able to tap into other financial resources like a credit card or loan to cover the immediate need and then simply repay it.
Being financially prepared
If you ignore opportunities to grow wealth, such as retirement accounts or other investments in order to build an emergency fund, you may be creating financial emergencies in your future.
Based on research, the average cost of a financial emergency is around $2,000 per year, maybe that should be your emergency fund goal if you absolutely feel you need one. Once you have that situated, you can look at other investments and ways to make your money work for you.