The Great Recession of 2007 drove home the common-sense notion of being prepared. Specifically, it gave a lot of traction to the idea of having a 6-8 month emergency fund.
Today, nearly every financial advisor parrots the same call — everyone everywhere should have months and months of living expenses socked away in an easily accessible account.
But is building an emergency fund always a good idea? And does the wisdom behind the advice translate to every financial situation? I don't think so. (See also: Put Off Saving for Retirement)
At the risk of sounding heretical, I humbly assert that every financial circumstance is unique and creating a hefty, low-interest, immediately-accessible emergency fund might not be the smartest way to manage your money.
Here are a few situations where it just might be okay to skip scrimping and saving to build an emergency fund.
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You Have High-Interest Consumer Debt
Unlike an emergency, your creditors are a sure thing. If you have credit card debt, those high interest rates will be applied month in and month out. But the interest you'll get from a bank on a savings account is something akin to not-worth-mentioning. Get more bang for your buck by paying off your credit cards first.
You Have No Retirement Savings
If you're young and trying to decide between funding a Roth IRA or 401(k) account and putting money away in case of emergency, bank on your retirement. The time horizon is long enough that you'll see real growth from compounding interest. Plus, with 401(k)'s company match and Roth IRA's tax-free growth, both types of savings vehicles can be powerful wealth producers over the long term.
You Have No Debt and Low Expenses
On the other side of the coin, if you have no debt and very low expenses, an emergency fund may not be the critical lifeline for you that it is for others. In an emergency, low overhead works in your favor and modest financial obligations can be met in a variety of ways besides a savings "super-fund." Redirect that cash toward investments that offer better long term returns.
You Have Investments That Are Accessed Easily and Without Penalty
Panicked about not having money saved for the what-ifs in life? Relax — maybe you already have an emergency fund and just don't realize it. Investment dollars that you can withdraw without penalty achieve the same goal (and may be earning a higher interest rate in the meantime).
You Have Flexible Finances
If you're financially flexible and can easily contract in the event of a temporary layoff or unforeseen income hiccup, maybe an emergency fund isn't an absolute essential. Having some serious wiggle room financially has some real rewards — and not needing a huge emergency fund is one of them.
None of this advice is meant to suggest that preparation is a bad idea. Being financially alert helps us survive, thrive, and seize amazing deals when they come our way. But bloated emergency funds, built only by ignoring other wealth producing opportunities and applied in one-size-fits-all fashion just don't make sense.
In other words, sometimes the best preparation is knowing what we don't need to prepare for.
Do you have an emergency fund? Is your fund in a traditional savings account or another type of investment?
Is Building an Emergency Fund Always a Good Idea? By Kentin Waits on 27 February 2013 LINK