It continues to perplex me why there should be a distinction between an emergency fund and your general savings. If you have $100,000 in the bank, what is the difference between calling it $100,000 in savings, and splicing the funds into $10,000 emergency money and $90,000 savings? The answer lies in the fact that people who need to create an emergency fund likely always have “emergencies” and are weak with their spending and savings!
Let’s say your name is Mr. Benjamin aka a $100 dollar bill. You’re relaxing with your fellow Benjamins in the bank, hopefully earning at least a 2.5% interest rate using the “DVD Method To CD Investing” and having a grand old yield maximizing time. A Benjamin’s purpose is to provide a solid source of liquidity and risk free interest income for the owner upon his or her retirement.
Some Benjamins are lucky. Their owners don’t discriminate between one bill or another. They treat each bill with vital respect i.e. they don’t touch it! Some owners are just nutty, always disturbing their party and separating one Benjamin from another. “Listen up Benjamins! 100 of you are to relocate to this side of the tracks, and the other 900 Benjamins get to kick back and relax!”
YOUR CRUTCH WHEN YOU CAN WALK JUST FINE
As soon as you start identifying some of your savings as emergency fund money, that portion becomes “at risk.” Your emergency fund becomes a slush fund that tempts you to spend because you don’t have the discipline enough to lock away your retirement money. You bring your savings to the front lines, allowing you to justify your desires because you’ve earmarked other monies for retirement.
Having an emergency fund is a crutch. You start thinking in emergency fund type increments. That’s a lovely iPad my emergency fund can cover no problem! Or, let’s buy a brand new car and take out a loan since our emergency fund can take care of the payments! 1/10th rule for car buying? What’s that! The list of stuff you start wanting gets longer and longer until you no longer can control your temptation.
Worse yet, some of you might treat your emergency fund money like gold and never spend it! What does that mean? It gives you a green light to spend all your other money at will because you feel artificially complacent that no matter what, you’ll still have your piddily emergency fund to depend on. This could be the more dangerous result, since an emergency fund is generally only a small fraction of your overall savings.
LOOK AT YOUR FINANCES HOLISTICALLY
As soon as you identify the weakness of the emergency fund concept, you’ll realize that you’re just making excuses for your spending and savings habits. Instead of creating an emergency fund, go broke to win big and lock your money away. If you have to create an emergency fund, you are scraping at the bottom of the barrel with regards to your personal finances.
Do you think multi-millionaires have emergency funds? Nope. They have tax efficient muni bonds, private equity investments, and liquidity. Stop thinking so small and start thinking bigger, holistically if you will! A dollar here is the same dollar there. Focus on fixing what’s most important, your money habits.
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Updated for 2019 and beyond.