Monday, October 14, 2013

Emergency Fund - It's What's for Dinner

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Robert Mitchum was the spokesman for the Cattlemen's Association advertising campaign, "Beef, it's what's for dinner."

Now I don't want to offend my vegetarian readers, but the Cattlemen didn't need to tell me that - I just about always have beef for dinner.

But when it comes to emergency funds, I like to think of this ad campaign. Here's why!


What is the Purpose of an Emergency Fund?


If I were to do an ad campaign for emergency funds, it might be, "The Emergency Fund - It's What's for Dinner."

This is because the main function of an emergency fund is to be there for you - like the name says - in an emergency.

If bad times hit, an emergency fund's job is to put dinner on the table and pay the mortgage or the rent, get the car repaired, pay the electric bell, and such.

An emergency fund's primary role is to provide for the necessities of life in an emergency or during bad times.

 

Where Should Emergency Fund Monies Be Held?


One of the more controversial issues regarding emergency funds is whether they should be invested or kept in a cash vehicle.

The traditional view is an amount equal to three to six months living expenses be kept in cash or cash equivalents such as savings accounts.

But there are also those who argue that by investing emergency fund monies a better long term return may result. This argument is being exacerbated by the current low interest rate environment.

In situations where emergency funds may be necessary, I believe investing the monies is not the correct approach. I commented on this topic in a recent Wall Street Journal article, "Keep Emergency Funds in Cash or Invest?"


One Size Does Not Fit All


In the world of financial planning, everyone is different. This also applies to emergency funds.

For example, Warren Buffett probably does not need an emergency fund. Nor does a retiree with a pension, Social Security, no debt, and a low cost of living (although it would still be a good idea).

But a young family with a mortgage, high health insurance deductibles, debt, and little liquid assets and savings, very much needs one.


If You Need an Emergency Fund, Keep the Monies in a Cash Equivalent


The moral of the story is if the monies really are needed in the event of an emergency, keep the funds in a checking or savings.

Here's a look at why. Let's consider as one alternative for investing an emergency fund: Corporate bonds. Here a look at look at the Dow Jones Equal Weight U.S. Issued Corporate Bond Index over the last ten years.

Note what happened during the Great Recession of 2008. The asset class was down significantly.

When, as a general rule, are you likely to need an emergency fund the most? When times are bad - such as during a Recession. This is also when invested funds are most likely to be down. So investing an emergency fund can mean your emergency fund could have an emergency, and just when you need it most.

The moral of this story is if you need an emergency fund, for many, the best option is to keep the monies in a cash equivalent which is not subject to market fluctuations.

That way your monies will be there if you really find the emergency fund is what's for dinner.


Disclosure: Past performance is no guarantee of future results. Investing is subject to risk which may involve loss of principal. The value of bonds will decline as interest rates rise. The fast price swings in commodities and currencies will result in significant volatility in an investor’s holdings. Real estate involves unique risks and may be subject to illiquidity. There is no assurance a diversified portfolio will outperform a non-diversified portfolio. Diversification does not ensure a profit or guarantee against loss.