This is a repost of a post from last year. I’ve been in all day meetings in Philadelphia, commuting back and forth, so if you are reading this, I haven’t had time to write a new post, and this one has appeared through the magic of post scheduling. We’ll be back to our normal programming next Friday.
I saw a post on a blog a couple of days ago from a self proclaimed expert explaining the need for an ‘Emergency Fund’, and I thought a post might be in order.
In plain language: if you have any consumer debt (credit cards, car loans, etc), you should not have an Emergency Fund if your goal is to increase your net worth. There is no reason to pay interest to save money.
Lets say you have $10k in credit card debt, and you are paying 20% interest on that debt. You decide you need 6 months after tax in the bank as an emergency fund, in case you get laid off, or hit by a bus, or mauled by a dog, whatever. You make $60k a year, so you need about $20k in the bank.
Think about that for a minute. How long would it take you to save $20K? And you want to not pay off your credit cards for that long? A significant “EF” is a huge mistake if your goal is to increase your net worth.
If your goal is to increase your net worth, you have to get out of debt. If there is no direct need for the cash (what are the actual odds you’ll need the fund? If they are high, then it’s not an emergency, it’s something that should be in your budget), pay off your credit cards and your car loan, THEN gather 6 months cash.
My suggestion is to have a 2 week cushion over your budgeted needs so you aren’t literally paycheck to paycheck. You don’t want the timing of due bills doesn’t create any issues. But more than that, you are paying interest on money you don’t need to just sit there.
If you do find yourself in a position you need more than a paycheck’s worth of cash for something (the transmission is shot, need to repair that roof leak), use the available credit you’ve created by paying off your debt. You are still better off, because you haven’t been paying interest on that money while it sat doing nothing, you only have to pay interest on it while you need it.
If you are disciplined, it won’t be long before you are out of debt and paying for those emergencies with cash you have saved. Saving while you are in debt or while you rack up more debt is the main reason people struggle to build wealth.