Do Credit Cards and Stocks Make Up Your Emergency Fund Savings?
Published 6/18/08 (Modified 3/8/11)
Life is unpredictable. As much as we may try to project what is to come in the future, our feeble attempts at fortune telling and soothsaying inevitably fall short of reality. That's life and that's just the way of the world. We may try to walk the steady and safe path paved with good intentions, but sometimes life just insists on chucking a banana peel to trip you up when you least expect it. It's not always fair and it's not always just. Bad things happen to good people and sometimes unfortunate circumstances befall even the best of us. But the unforeseen and the unexpected don't have to ruin our lives and cause everything that's going for us to fall apart at the seams. We can plan for such an occurrence and protect ourselves the best we can by creating a back up financial contingency plan. Having a "Plan B" savings account and readily accessible emergency fund set aside will give you piece of mind in knowing that you will be taken care of should the worst case scenario occur.
I've personally had many unforeseen and unexpected situations spring forth in the last couple of years, and have learned that life comes at you fast. In the last few months, I've had to deal with a family health emergency due to the sudden passing of my grandfather which required me to go on emergency leave to fly overseas to be with him. I've also had to deal with a significant tax liability bill recently that seemingly came out of no where in the tune of almost $10,000. Most recently, my car suddenly broke down, necessitating me to pay out a good chunk of cash - $80 for an emergency taxi ride, $140 to tow my car to the car dealership for servicing, and an additional $1,200 for the cost of repairing my vehicle's broken alternator, car battery, and to replace the break pads. All of these sudden expenses are part of the natural course of living but they weren't expected. Thankfully, I've learned to practice what I preach and have been able to maintain sufficient emergency funds to deal with most of my financial emergencies.
Anticipate the Unexpected, and Save Up Enough Money In Readily Accessible Accounts To Cover Several Months Worth Of Living Expenses
There is no hard and fast rule as to how much one needs to have stored away in an emergency fund, but most personal finance bloggers such as myself advocate sufficient liquid savings to survive for at least a few months with no incoming funds. That is, you need sufficient savings to pay for the cost of living in case you are suddenly bed ridden for whatever reason, at least until you can get back on your feet and generate income again. Personally, I keep at least $5,000 cash stored in my bank account for emergency purposes that I try my best to not co-mingle with other investment objectives. That amount of money that I keep aside is designed to handle financial emergencies such as sudden large tax bills, health related injuries or medical bills, emergency car repair, and even the lack of income due to unanticipated unemployment. While some financial advisers advocate earmarking one's backup emergency fund savings to cover only truly emergency living expenses, I personally take a broader approach and use my���� emergency fund money as a monetary buffer for various out of the norm, over the limit type expenses that include necessary car repair charges and unplanned vacation trips. Of course, I make a very strong effort to rapidly replenish the funds as soon as the temporary financial emergency crunch subsides.
So what should we consider as ideal assets for emergency fund planning purposes? Obviously the best sources are ones that are very liquid, that earn interest, that imposes no penalties or interest charges for withdraw, and those that are easily accessible and able to be withdrawn at a moment's notice preferably in cash money form or equivalent. The most liquid form would clearly be money stored in a piggy bank or bills stashed under your mattress, but with bank branches located everywhere and interest generating accounts easily accessible through the Internet and 24 hour ATM machines, bank related holding accounts are the supreme form of emergency fund savings. Such bank related accounts and assets would include checking accounts, savings accounts, certain forms of laddered CD's, and money market accounts. The recommended emergency fund storage solution for most people would be to keep at least 3-6 months worth of living income stored in a high yield savings account or money market account. Bank savings and money market accounts (not to be confused with broker based money market funds) are ideal for emergency fund saving purposes. They offer not only high interest earning opportunities but they also provide instant account access, allowing funds to be withdrawn quickly for emergency situations.
While it's nearly unanimous that putting your money in a high interest savings account is the best way to save and contribute to an emergency fund, there is much greater debate when it comes to two other commonly used forms of emergency funding - money invested in the stock market, and credit cards (specifically 0% credit cards that offer introductory 0% APR interest for balance transfers).
Using Your Stocks, Mutual Funds, or Retirement Savings As Your Emergency Fund Is A Bad Idea
Personally, I have used my brokerage account as my emergency fund before, however I highly advise against the practice. Not only is the money not very liquid and difficult to convert to immediate cash to pay off emergency debts, but oftentimes such hasty and immediate sales of stocks and mutual funds end up being very counter productive and detrimental to one's overall long term investment strategy. Currently I have a decent amount of money invested in various individuals stocks, mutual funds, and exchange traded funds (ETF's) through my online discount broker. Most of my brokerage money is being invested as part of a long term investment strategy. Having to sell my equity positions immediately and prematurely would disrupt my investment approach and force me to incur unplanned short term capital gains or sustain premature capital losses. Worse yet would be to withdraw funds from one of my retirement investment accounts such as my 401K, Traditional IRA account, or ROTH IRA. Not only would I disrupt the compound interest process that such tax deferred retirement accounts offer, but the withdraw itself may require me to pay out hefty early cash out penalties. While your investment account is obviously there as a final dead end source of money, one should look to other more liquid and less financially detrimental sources of emergency funds.
I Frequently Use No Fee Balance Transfer Credit Cards To Handle Emergency Expenses, But The Practice Is Only Suitable For Those Who Can Responsibly Handle Credit Card Bills and Payments
The use of 0% credit cards and balance transfers is my favorite and most commonly used source of emergency funds. I know this practice is highly frown upon by anti-credit card types, but it's worked well for me over the years. Of course, the use of credit cards and particularly the practice of carrying large balance transfer balances (even at 0% APR) isn't suitable for everyone. For those that have a history of overspending, or who have not demonstrated a responsible and mature ability to micromanage credit card balances, payment due dates, and minimum payment requirements, 0% balance transfer credit cards should be avoided. Those that can't properly handle the use of credit cards and manage the logistics of balance transfers will risk making a terrible balance transfer mistake and wind up getting themselves into deeper financial trouble with credit card debt than they started out with. But for those who know how to make a balance transfer and know how balance transfer credit cards work, they are an invaluable financial tool to have in your emergency fund holster.
Back when I incurred a sudden and very unexpected $10,000 tax bill, I utilized my excellent FICO credit score to secure an attractive balance transfer card offer of 0% APR interest for 12 months. I utilized the 0% credit card's high credit limit to pay off the $10,000 IRS tax bill and took advantage of the balance transfer card's one year introductory period to slowly pay off the credit card debt which was basically the same IRS tax debt except in a much more manageable no interest form. Because I was diligent in making regular payments, I eventually paid back the entire liability and incurred absolutely no interest or penalties in the process. Balance transfer credit cards, when used properly, can help get you through such tough times and offer you a readily available source of interest free funds when you need them the most.
Of course, if the sudden financial emergency is quite substantial and the amount owed greatly exceeds what you anticipate being able to cover within the balance transfer card's introductory rate period of 6-12 months or longer depending on whether you can keep rolling the balance onto a new 0% balance transfer credit card offer, I would suggest using something like a low interest balance transfer credit card for the life of the loan instead. While you'll be paying a little bit more with a low interest balance transfer, at least the payments are predictable and you can take your time making regular payments towards paying off the bill without worrying that interest charges will drastically spike after the promo period is over.