22 Feb 2010

No, You Don't Need a Large Emergency Fund - or Convince me That I am Wrong!

I recently have written a post about the myth and fallacy of an emergency fund and why I don’t want to have one. This led to a lot of discussion and a lot of people disagreed with my view.
I have just completed a guest post for Penny’s blog about MBTI type and their attitude to money and while researching for that post I also came across an interesting study about the link between the MBTI type and risk.
Since Emergency funds are all about mitigating risks and hedging your bets looking at MBTI type made sense.
Sonya Zichy conducted a survey asking participants about their investment preferences.
In summary - type seems to have the highest impact on risk tolerance, the financial planning process and level of interest in investment issues and less impact on actual choice of investments such as stocks and bonds.

No wonder that I don’t like emergency funds!

I’d much rather prefer to have several insurance policies to cover me for long-term illness, death, structural damage to my property. I mean the math is easy – to have enough money to actually be truly protected in case of an emergency I would need to save for at least five-seven years!

Now, the math is simple – I have to assume that NOTHIG bad happens to me in the next 5-7 years AND in order to save up quickly I will be quite tempted not to pay for most of the insurances as I would try to save money into my emergency fund.

Chances are that if anything happened in the next 5-7 years my emergency fund would cover me for only a couple of months (that’s the idea, isn’t it?) Something that only takes 2-3 months to recover from could have not been THAT bad in the first place!

As I am married and we both work full-time the earnings would be down by 50% not by 100% - so all we actually need is something in the area of 60% of all our expenses covered for 2-3 months

This equals 2 of my salaries and I could save them in under two years – emergency fund done!

At the same time I will be covered through my insurances and as we are saving for long-term spending (car repairs, holidays, irregular bills, etc.) it is unlikely that I would use this emergency fund for anything rather than: unemployment, time off sick with my child, covering excess on any insurances I would need to use to cover big emergency spending.

Psychologically I feel way more motivated to aim for 5000 savings rather than for 18000. Being motivated means I am more likely to achieve more of my goals.

The probability to both save for emergency as well as to have appropriate insurances in place, continue to overpay on our debt and save for planned spending all at the same time is much higher!

I wonder how many people stop saving for other goals and are not taking out insurances because they think emergency fund is their priority and who are horribly exposed to all sorts of risks if anything happens to them until they have saved enough!

So, my personal advice remains – all you need is a good portfolio of insurances plus money to cover for 2-3 months of expenses (or part of it if you are in a partnership), and enough money to pay excess on your insurances. This is way less than 6 months worth of expenses (or even income) as some “gurus” recommend you save for!

I hope you share your view on emergency fund savings too. Do you wholeheartedly agree with the idea of 6 months savings? Am I being naïve?

image by specialKRB

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