They are money for emergencies. Yes, you need one. See, that was easy!
But wait, if it’s that cut and dried, why do they cause so much controversy in the halls of the Personal Finance space? And if you have one, how much should you keep? I’d like to parse out the various positions and come up with my own answer, one that can be useful to you no matter where you are in your journey towards your financial goals.
For a long time, famous people like Dave Ramsey have told everyone that the first step towards taking control of your finances is to build up an emergency fund. Many recommended to have around 3,600 AED in a checking account for those “just-in-case” sort of situations like your car breaking down, a roof leaking, or a family member having to go to the hospital unexpectedly. Many people around the world are living paycheck to paycheck, with no savings, and are one unexpected expense away from disaster.
When people are in this situation, having an emergency fund can be the difference between paying an annoying bill and going into debt with a high interest rate that sucks up more and more money, or even not being able to pay your mortgage or car loan. People have gone homeless for less. So, here, your first priority needs to be setting aside that money, even if you have a credit card. Credit cards often have extremely high interest rates (around 45% per year in the UAE), and if you have to put a large, unexpected bill on it and can’t pay it off, it can quickly spiral out of control. That sort of debt can keep you trapped in the country or even get you arrested.
After people have their 3,600 AED emergency fund, the next step for many is to have between 3-6 months of expenses in cash, so that they can live for an extended period of time without a job. Any money saved beyond this goes into buying investments like stocks, bonds, and real estate. For many people, this gives a deep feeling of comfort because they know that they’re ok for quite a while in case something terrible happens to their career. It can even give people the motivation they need to take calculated risks like changing careers or leaving a terrible job.
On the other end of the spectrum are people like Mr. Money Mustache, an extremely popular Personal Finance blogger, who says that people usually don’t need emergency funds.
His point in his youtube video “MMM vs The Emergency Fund" is that emergency funds stop your money from working for you. Once people get out of debt, keeping money in a 0% interest checking account is just harming your future wealth. As long as you save a considerable amount of your paycheck, like 30-75%, then any emergencies can be paid for by what you would normally save. If there’s an emergency beyond that, he recommends that you pay for it by selling stocks or bonds.
To me, the answer to the question of “do you need an emergency fund” depends on where you are in your journey, and how much monetary comfort you need to sleep well at night. I keep one year of expenses in cash, because that’s where I feel comfortable. But, it’s one year of expenses for living in a very inexpensive country, like Thailand, where I’ve calculated that I can live for about 30,000 AED for 12 months. Is this the mathematically “correct” answer that maximizes my returns? No. But I also know that I have another 36,000 AED available on a USA based credit card, if push came to shove, and that makes me sleep even better at night.
I don’t like the idea that I could lose my job in an economic downturn, just when my stocks and bonds are losing a lot of value, and have to sell them at a loss to cover my expenses. In a downturn, I don’t want to sell assets if I don’t absolutely have to.
Is my answer right for you? Maybe. Maybe you like to live more dangerously or have other expenses I don’t have. But you need to ask yourself what you’re comfortable with, what the balance is between maximizing your returns and sleeping soundly at night. At the very least, have some easy access to cash, preferably in multiple countries and bank accounts in case something goes wrong with one of them.
Hopefully, you’ll never need it, but if you do, you’ll be very glad you have it.
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