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Is A Credit Card A Suitable Replacement For An Emergency Fund?

9 December 2009 No Comment

I’ve heard some criticism regarding the buildup of an emergency fund, typically referred to as cash put away that can cover 3 to 6 months of your expenses should an emergency occur.  These emergencies might be a loss of income, a medical emergency or some other large, unexpected expense.  The idea is that having the cash set aside prevents you from having to go into debt in order to get through the unusual, temporary  circumstances.

If these funds are designated for truly an emergency, wouldn’t a credit card suffice?  Through it, you have access to money and can use it to pay expenses as necessary through your unusual circumstances.  I think that this strategy only works depending on a few types of emergencies.  For example, a large, unexpected expense such as a major repair bill or something of the sort.

I don’t think a credit card is a very good solution to saving up money to fund your entire lifestyle in the event of losing your job.  In this scenario, it makes much more sense to have 3 to 6 months (or even more) of money to pay for all of your expenses while you’re out of work.  When you get a new job, you can replenish the funds you spent, rather than pay off a credit card (plus interest).

The only argument that really goes with this type of strategy is that you would rather have your cash invested in a higher return rather than in an emergency fund earning a minimal return.  I think that having some of your assets sitting in cash isn’t that bad of an idea anyways, so an emergency fund is a good idea.  After all, it’s not like you’re losing money with having a pile of cash sitting there.  It’s secure and maybe even earning a small return.

My advice:  build up a large emergency fund.  If the fund continues to grow, you’ll have more and more cash.  Ideally, you end up with enough money to pay for a full year of your expenses.  At the same time, make sure you’re contributing to retirement accounts such as a 401(k) or a Roth IRA so that you can get the tax advantages of these accounts.  Bottom line… save, save, save.  Cut your expenses and save more of your income.  By cutting your expenses, you’re also making it easier to continue your lifestyle should you lose your income and need to live off your emergency fund.

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