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2 Reasons Why the Concept of an Emergency Fund is Overrated

Category : Personal Development, Personal Finance, Smart Investment Ideas

Most people can do extraordinary things if they have the confidence or take the risks. Yet most people don’t. They sit in front of the telly and treat life as if it goes on forever. – Philip Andrew Adams

‘An emergency fund’ is an omnipresent phrase in the blogoshpere. Most personal finance blogs discuss the need to have an emergency fund for all the valid and obvious reasons. I get it. Nonetheless, seldom I see the other side of the argument.

I found an article written by Jeremy so engaging as it resonates well with my own life.

I came to America almost 20 years ago with a dream and $20 in my pocket. I wanted to build self-confidence to prove myself that you can fly from one corner of the world to another and build success from scratch. If I waited to build an emergency fund to fuel my dreams, I doubt that I’d have dared to write this article.

Before you nod your head in disbelief, I am not subscribing to an irrational approach of financial recklessness.

I believe that building your self-confidence is infinitely more important than building an emergency fund. Think about it. Most immigrants — I am one among millions — come to this great nation and build their financial future by savings as if there is no tomorrow and taking risk to invest their capital instead of playing too safe by keeping large sum of cash in their savings account.

1. It can work against your dreams

Why you need a rainy day fund? It’s to insure, to some degree, that you can deal with an adversity. Most of us are poor at judging our future, let alone judging unforeseen need for a rainy day cash to deal with unplanned expenses. It’s very hard to know how much cash you will need for such an event.

If you are building a large sum of an emergency fund, you are sabotaging your dream to either start a business or to take healthy risk by investing your capital into an investment so that you can focus on generating steady stream of income from various sources. These income sources can become your pseudo emergency fund.

Have you ever witnessed a rocket launch?  Your emergency fund is nothing more than a launcher for your dreams. Once it fuels your dreams, let your dreams fund money for the unplanned events in your life. You need cash initially for the first few years in the business to let it grow, but having a huge sum of cash in your savings account is self-limiting to your desire to think big in the long run.

2.  It can hamper your financial growth

Those of us who keep a large sum of cash often don’t consider two factors working against our financial growth — Inflation and Uncle Sam. Most savings accounts return on average much less than the rate of inflation. Your sense of financial security is thus costing you thousands of dollars in the long haul.

American tax code is written heavily in favor of those who are risk takers — by investing in businesses and real estate. If you choose to have your cash in the bank, it’s not only losing value every year but also making your silent partner happy.

It’s obvious that if you are doing well financially then it’s better to allow cash flow from various sources of income to fund unexpected expenses. “But what if you are dealing with credit card debt?,” You might ask. If that’s the case then it’s even better reason to pay off debt before thinking too much about an emergency fund. You can always use instant cash from your credit card than to have cash set aside while you are paying insanely high rate of interest on your credit card.

It’s important to build self-confidence by building assets that are appreciating in value in the long run than to focus on building a cash reserve. I’ve never even consciously thought about having a rainy day fund in a long while. My focus, instead, has been to live modestly while building the portfolio of various assets that can provide cash flow to live happily.

If you save as if every day is your last day at the job, you can instead focus more on taking calculated risks to invest your hard-earned money to generate cash flow. You can auto pilot the entire concept of an emergency fund with that approach. Do you agree?

Readers: Have you ever given thought to the ideal amount you need in your savings account? Or do you really need a rainy day fund at all? Do you have plan to retire the concept of the rainy day fund?

Elsewhere:

Does Everyone Need an Emergency Fund? @ModestMoney
Can Your Emergency Fund Actually Create an Emergency?@opportunitiesaplenty
 5 Ways to Motivate Yourself to Save @ Pickthebrain
Using Dogs of the Dow to Buy the Best Dividend Paying Stocks @ MyMoneydesign

 Photo by: Tax credit

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Comments (30)

Thanks for the mention Shilpan. Glad to hear that my post inspired you to share your own views on this subject. I do think a small emergency fund is good to have, but to me it doesn’t make much sense to have a lot of money just sitting in a savings account just in case. You make some great points about how it can really be holding you back. That money really can be put to much better use.

You’ve really hit the nail on the head, Jeremy. I am not against having a small amount in the savings account, but I’ve never given much thought to an emergency fund. You’ve articulated some very interesting thoughts about this subject.

What a very interesting counter-argument to having an emergency fund! I think emergency funds have so much popularity because they appeal to the masses. If you screw up, you’ve always got your emergency fund to fall back on. Most people ARE NOT risk takers and probably have never considered the erosion caused by inflation or taxes.

Despicable returns are why I have always struggled with my emergency fund. The money I have ear-marked is actually sitting in a mutual fund (something most people would disagree with). I need to know that the money will grow faster than inflation and, because its an emergency, I should never need to touch it!

Agreed. I am not against having an emergency fund, but keeping large sum in savings account is not a prudent strategy even if it is tagged as an emergency fund.

I take your point as being hard work, desire, ambition, and perseverance can overcome just about any obstacle or challenge, and I agree. Congratulations on your success!

Thank you for the kind words, Kurt.

Shilpan,

Once again, you’re hitting the proverbial nail on the head. Here’s a third reason, from a post I wrote back in 2007, about why it may be a good idea to skip the emergency fund so many others recommend.

http://opportunitiesaplenty.com/Debt_Blog/2007/07/_can_your_emergency_fund_actually_create.html

Steve

Now, I am heading over to your blog, Steve. Thanks for stopping by.

I like the idea of “investing in yourself” this post has. I personally feel everyone needs an emergency fund but not nearly one as big as people are suggesting.

I have money in my emergency fund, but I’m scared to spend it on paying down my student loans now that I am employed again because I’m uncertain about the future. What does that say about me?

There isn’t one size that fits all, Lauren. I consider paying down debt as #1 goal every ought to have. If you are employed, keep a small emergency fund but try to pay down debt.

Jeremy’s post was a great one, and this is a great “follow up.” Emergency funds are great, but it’s gotta be done thoughtfully. Becuase you’re right, you’re working against inflation and that pestering Uncle Sam. My wife and I do keep an emergency fund, but we aren’t letting it get too big because any money over what we think we need should go towards investing, etc!

I can’t agree with you more, TB! Well done.

i am a big advocate of the emergency fund.. but more in the dave ramsey sense, than the suze orman sense..

i think everyone should have $1000 in the bank to handle life’s emergencies.. yes, if you took that thousand dollars and invest them into a startup or something, you could potentially reap huge benefits.. but what happens if your car breaks down the next day? how will you handle it? credit cards? selling off the investment you just made?

having a huge emergency fund equivalent to several months salary seems excessive, however, unless you are in a stable place already. your money would better be spent purchasing assets and improving your bottom line than stockpiling it away, tens of thousands of dollars at a time.

That’s the gist of the article, Jefferson. I see plethora of advice about the importance of an emergency fund, but not much in terms of who really needs it. A small amount is, of course, good to have, but it doesn’t make sense if an emergency fund is a substantial portion of your total assets.

Thats a very interesting way of looking at an EF. Personally, I like having a backup, even if I never use it, I like knowing that I don’t have to ask anyone else for money if needed.

Agreed. How do you decide the amount that you need to keep aside? Just curious.

I think emergency funds have their place but they need to be planned appropriately. They can’t be the only thing you have and they should only ever be allowed to get so big. We have an emergency fund but we also have numerous other savings accounts that are set towards other goals. We try to balance it out.

Have you thought about any other instruments that are safe yet providing better return compare to your savings account?

Man, I’m usually right there with you, Shilpan, but not on this one.

I think an emergency fund is ALL ABOUT people’s self confidence. If I know that I am adequately funded to withstand horrible events, I can be far more daring without worrying about what happens halfway through the project when I run out of funds.

I can then take HUGE risks in my portfolio if I want, because I don’t need the cash right now. Therefore, while that particular dollar doesn’t beat inflation, my portfolio has a far better chance of kicking the pants off inflation because I don’t have to worry about short-term market results and can focus on making long term gains.

I wouldn’t be caught dead without an emergency fund BECAUSE I’m a risk taker, and can’t think of one successful entrepreneur I met along the way without one, either.

I respect your opinion, Joe! And I agree that the emergency fund is needed, but you have to go on offense and build assets (both hard and liquid) so that when you need money, it’s not a juggernaut’s act to rely on a savings account. With so many options available, you can have your money work for you with relatively ease to cash in the investment, if needed. That’s my point. Thanks for your thoughtful comment.

Joe’s point is one I’ve been thinking about lately. In this post:
http://jlcollinsnh.wordpress.com/2012/05/12/stocks-part-vi-portfolio-ideas-to-build-and-keep-your-wealth/

I describe some portfolio ideas, the last of which calls for a large cash position to enable a very aggressive/high growth stock position for the balance.

I’d be interested in your and Joe’s thoughts on the idea, as well as anyone else who might care to comment. I’m still mulling it over….

What a surprise to hear from you, Jim! I hope that your trip to Peru is going well. I will read your post and give my 2 cents. I can’ wait to have you back in action after your well deserved trip.

[...] back to your regularly scheduled programming… 2 Reasons Why the Concept of an Emergency Fund is Overrated on Street Smart [...]

I found your Blog very interesting and you always write such an intelligent article. it’s not only fun reading but it’s very inspiring! actually i am lazy in reading but your articles have captivated me, and kept me going on…

thanks buddy…..

Thank you my friend for stopping by.

The American tax code is written heavily in favor of those who are risk takers. The is a great point. It’s the risk-takers who achieve success and receive the greatest tax advantages. I agree that using your savings to fund your dreams is a lot more financially sound than saving for an emergency.

Yes, if you keep too much money in your savings account then someone else is reaping the benefit by borrowing and starting his/her business.

First time commenter here. I agree with the premise for sure, but I am an advocate for having an emergency fund for the same reasons you are against it. For me, we were able to cut our house down to one income due to our emergency savings. And since we only have one income, I’m already taking a huge risk. Our emergency fund allows us to stay motivated, because even if life hits us, it doesn’t knock us down.

I do hate the lousy return, and am looking at splitting my emergency fund into investments hopefully next year, but not having one is just too much risk to the point where I’m just scared, not confident.

Great post, and interesting POV. Thanks!

Great points, Jacob. I am not against having an emergency fund; I am simply against living like a frog with fear instilled in my mind. Of course, you should have enough to handle small hiccups, but having too much sitting in your saving accounts won’t be healthy for your finances.

[...] how you should rethink an emergency fund? Well Shilpan took that idea and ran with it, making an awesome followup with even more thoughts and [...]

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