I’m in Debt! So why should I have an emergency fund?

by Mike Holman

PaidTwice of www.paidtwice.com has kindly written a guest post with her thoughts on having an emergency fund. PT started her excellent blog to document her family’s journey to get out of debt. If you want to read an upbeat debt reduction blog written by someone with a PhD who works at home with her two young children (I didn’t think it was possible) then I strongly recommend checking out her blog.


There are many schools of thought on if someone who is in debt and working to pay that debt down should have an emergency fund. The money that sits in the emergency fund could instead be applied to debt reduction and help the person get out of debt just that much faster. Well, I am here to say that I am firmly in the “have an emergency fund” camp. Not a fully funded, extensive, cover any possible contingency emergency fund, but something that you can fall back on if small things come up so you don’t need to resort to using credit and increasing your debt.

Debt is more than a financial predicament. It can become a state of mind, and also a recurring behavior. If the only thing you have to fall back on if something unexpected comes up (and, just assume that something will, at some point come up) is credit, you can feel like you are just sinking back into the hole of debt you are already in, and it can erode any feelings of progress you have made. Personal finance is about taking control of your money, but it is also about personal behavior. Once credit is again used, it can become all too easy to keep using it, and end up worse off than when you started debt reduction. It can also begin to feel hopeless and not worth it if the debt continues to rise even when you feel like you are trying to reduce it.

But what if you’re sure you won’t fall back into the pattern of accumulating debt if you have a setback? That is where I feel I am, and yet I still would rather a cash emergency fund rather than a credit safety net. Why? Because debt is an oppressive weight. Debt makes me anxious, on edge, and simply the idea of using a credit card I won’t be able to immediately pay off and putting myself further into debt just makes me edgy. I feel the interest I am paying adding up deep in the pit of my stomach. The feeling of peace I felt when we finished saving our $1000 emergency fund is really unexplainable. No, $1000 can not cover any conceivable emergency, but it can cover a whole lot of things that might come up. Knowing that I won’t need to immediately turn to credit if my car breaks down or I get sick is a very good feeling. I wish I could bottle that feeling and sell it. That’d help the debt reduction!

As for the emergency fund, ours is $1000 and it will increase over time… once we are out of debt. My spouse and I have not quite decided exactly how much we want in it, but at least 3 months of expenses if not up to 6. It is an ongoing process. That is really a personal decision based on what kind of emergencies you might be able to foresee and also your own life circumstances, but I am not recommending $1000 as the end all of emergency funds. But for someone who uses every spare penny to pay down their debt, that $1000 cushion is a lot to reserve. But completely worth it, in my opinion, is for nothing else, the peace of mind it provides.

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{ 16 comments… read them below or add one }

1 moneygardener

I know few people who are debt free (ie no mortgage, no car loan). So it sounds like you are advocating that basically everyone should have a ‘cash on hand’ emergency fund?

I disagree with you. I will post why on my blog at some point soon.

2 FourPillars

Personally I don’t like to have one since I’d rather rely on line of credits but that said, we usually have around $3000 in our accounts – I normally think of this as a “cash buffer” rather than an emergency fund but it kind of works out to the same thing.

Mike

3 moneygardener

I keep as little money as possible in the bank. We will often have less than $100 of cash in our account just prior to one of our pay dates.

4 Matt

Having an emergency fund is extremely important and it can bail you out of life’s unexpected hiccoughs when they occur. Unfortunately the hardest part about setting up and emergency fund when you’re in debt is the fact that its hard to set aside any form of money. When it comes to choosing to pay your debts on time versus putting money into an emergency fund (which happens for many people) I would say keep paying your bills.

5 Nobleea

Like Moneygardener, I try to have as little money as possible in my bank account. It is usually less than $20 just prior to a pay date. The money isn’t working for me if its sitting in the bank account, generating 0.025% interest. I have the line of credit for emergencies, though I don’t expect many – both condo and car are on warranty. Once I have kids, a house, etc, I can see having the desire for a proper emergency fund.

6 moneygardener

It is my belief that if you have non-registered investments there is no need for a ‘cash on hand’ emergency fund. If all went to ‘hell in a handbasket’, I can instantly have access to thousands of dollars with the click of a mouse. That is if I chose not to use my significant LOC.

It is hard to imagine a scenario where I would need excessive cash for an emergency, however if anything ever happened like this, selling a stock would be the least of my concerns. For me having a ‘cash on hand’ emergency fund would be excessive insurance against a low probability event, and opportunity loss as Noblea points out. There is enough insurance cost in life.

7 FourPillars

MG – I don’t know if I want to have that little cash on hand but you’re right – I should manage my cash a bit better since it’s not earning anything in my cheq account.

Mike

8 telly

I’m with MG and Nobleea on this one as well. We’re usually down to our last $40-100 when paydays roll around.

The line of credit is there if we need it (we keep a + balance (or technically negative) in it and use it as our chequing account anyway). If an emergency came up, our cash flow is pretty good such that we could probably take care of paying off most emergencies within a month or two.

Now if we were living off one income or were pretty tight with the bills etc., I might opt for an emergency stash…

9 FourPillars

One reason I do keep a bit of money in my account is so that I don’t have to watch the balance so closely.

Mike

10 the Wealthy Canadian

I despise non-constructive debt (unless it is of the zero interest kind) but cash in a chequeing account is losing the battle with inflation. I prefer to some ‘almost cash’ (accessible within a day) on hand, it’s in a high interest savings account. Various types of money market investments would also work but I think they are all less liquid than my savings account which I can access within less than 24 hours.

The problem with using your stocks as an emergency fund is that it eliminates your power to exercise a good exit strategy. If the market is down, you may end up taking a huge hit.

The LOC is a good buffer, however, it can lead you down the same path. If you find yourself down on luck and interest rates go up you now have a growing destructive debt.

11 moneygardener

Whether the market is down or not one will always own a stock that they could sell in a pinch and not ‘take a huge hit on’.

12 Mrs. Pillars

I believe it depends on the circumstances. There was a time when I was single, had no assets and was paying off a student loan. At that time, I was working in a month-to-month contract position and felt that having a few months worth of cash available was critically important. I agree with PaidTwice that debt is oppressive.
Times have changed for me, I am happy to say. Now I feel less need for a stash of cash in spite of more responsibilty (one small son) and a much larger debt (the mortgage). My attitude toward debt has changed over the years and I now have assets to work with if something should happen. Besides, I have Mike and that probably makes the biggest difference of all.

13 SHEILA

I am also a strong advocate of an emergency savings account, and I keep mine in a high-interest online savings account. I put the interest I earn to work for me, by using it to pay off debt or fund another savings goal.

I also have a small savings account at the bank (just a few hundred dollars), to cover irregular expenses like car repairs or license tags, vet bills and the like. The rate of interest is paltry, but the account is handy, because I can make immediate transfers.

The bank savings account and the online emergency account allow me to breathe easier while I am paying off loans.

Credit lines may work well for other people, but this is what works for me. Frankly, I would have sleepless nights if I did not have a small pile of money in reserve.

And that is the point, isn’t it? What works well for one person may not work well for another. We all need to do some research and figure out a plan that will work well for each of us, given our particular spending and savings habits.

14 FourPillars

Thanks Mrs. P!

Sheila: Very well put.

Mike

15 telly

Aww….Mrs. P – how cute! :)

Mike,
We don’t have to watch our balances so closely (though I do) because we use our LOC as our primary chequing account. TD allows you to keep a positive balance in your LOC accounts (and do direct deposit of pay cheques and such) so it’s essentially a free chequing / free overdraft account. We rarely dip into the LOC but when we do it usually results in

16 FourPillars

Telly, I’ve heard you can do that with TD. Sounds like a great plan.

I’m not too concerned about this issue since I don’t have huge sums of cash sitting around in bank accounts (it’s mostly under my mattress).

Mike

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