Why a Traditional "Emergency Fund" is a Bad Idea
Now I am sure that I'm going to get a lot of heat for this one, so just let me say that if you do have an emergency fund, that is great, but you are only halfway there. In general, people start an emergency fund to set aside the funds needed in the event of a personal financial dilemma, such as the loss of a job, a debilitating illness or a major unforeseen expense.
In other words, for an EMERGENCY.
Putting money in a savings account is not quite the same thing. Savings generally have a purpose, while an emergency account is meant to help you out in difficult times when you really need the money. This way you don't need to make early withdrawals from your retirement accounts just to feed yourself or make ends meet.
When it comes to a real emergency, liquidity is not that important. You can get the money easily, but you don't need to do something as simple as reaching under your mattress to get it. This is why I don't think emergency funds, in the traditional sense, are being proposed to people properly. If you are one of those folks who has an emergency account, good for you! But if you are in the process of starting one this year, here are some things to remember:
1) Cash does not grow.
Setting aside physical cash in a savings account or under your mattress may guarantee that you'll have liquidity when you need it, but the same amount you put away today will be the same amount in the future and will be worth less thanks to inflation. Simple laws of time value of money should tell you that a dollar today is worth more than a dollar in the future and unless you have a way to combat inflation, you'll actually end up with less money when you really need it.
2) Emergencies are not expected to happen all the time.
If this is the case, put all your money in a savings account and use it accordingly. However, if you have tons of cash in a savings account and you've been sitting around waiting to get sick or lose your job in order to use those funds, it's really sad how much interest you missed out on.
3) You can sell and use money invested in a brokerage account just slightly slower than withdrawing from a savings account.
Unless a mob is threatening to kill you, there is no need to have money available faster, especially when the speed and accessibility is barely noticeable. Many people will argue that investing their emergency money is not practical since they won't be able to get to their money quickly. Is the point of having an emergency fund to put money in a place where you won't be tempted to spend it? If it's busy earning money in a brokerage account, you won't be tempted to touch it to buy that new handbag or get concert tickets. When a real emergency happens, it will be there, ready to sustain you for as long as you need.
4) Why not put money to work in a brokerage account or an Healthcare Savings Account (HSA) in order to make money grow?
Your emergency funds can be put into a brokerage account and you don't need to buy a bunch of potentially risky stocks. Even putting your money into one or two ETFs that trade in tangent with the stock market should suffice. In the end you'll end up with about 30% more money when you actually need it for an emergency. An HSA is a great idea in the event that you become seriously sick or injured and are unable to work. Money contributions to HSAs are not subject to income taxes, so this encourages many people to save.