Scrap the emergency fund!

Pushing your finances to the limit to create wealth

You'll read a lot in personal finance advice about having an emergency fund. Much of the time the writer will advocate to have roughly three to six months in cash ready in the unlikely event of losing your job. The idea behind the emergency fund is that after paying off your debt the next step in preparing your personal finances is to build a safety net in case times get tough. Whilst I understand the thought processes behind the emergency fund I have a couple of quibbles with it.

What about redundancy pay?

If you've worked at your current employer for some time, unless you're accused of some gross misconduct it is very unlikely that you will be fired. However, if your business or department isn't doing well, isn't performing, or doesn't have enough money then they might need to make some redundancies. Unfortunately, you could be caught in the crossfire and lose your job.

The emergency fund theory seems to suggest that you need three to six months of cash available but ignores the fact that redundancy pay may be issued. Redundancy pay differs based on your circumstances (your income, the law in the country, length of service, negotiated amount etc), however, the package may be sizeable. Hence an emergency fund may not need to be the size regularly recommended and may not be needed at all.

How quickly will you get back into employment?

Having an emergency fund that is the size of three to six months presupposes that you will not find a job soon after you're fired. You may have a skill set that is in high demand such that should you lose your job you'd be able to find another job quite quickly. Alternatively you might be willing to take any job in the meantime simply to continue bringing in cash.

Can you cut your spending?

In the event of losing your job and having a significant cut to your household income you might find that in reality you are able to live on far less than you were previously. Without a job you won't need to pay for commuting costs, you don't need to eat out in restaurants, you can stop saving in the short term and so on. As such, you probably don't need as much in an emergency fund as commonly advocated despite needing to survive for up to a few months.

Furthermore, losing your job may qualify you for certain benefits such as jobseekers which should take the financial strain off a little.

Don't you have assets to liquidate?

I would argue that even ignoring all of the above, you still don't need to build an emergency fund per se. I would strongly advocate investing in some assets that are reasonably liquid but still offer a decent return. For example, index funds and individual shares can be liquidated within a few hours (especially if managed online). Why would you need to hold your emergency fund in a special cash account - why not just invest it?

You are potentially losing out on interest income from holding shares. Let's say that you're holding six months income in cash amounting to £15,000. Your interest income earned over the year would be virtually zero at current interest rates. However, were you to invest in some shares paying a dividend of 5% per annum you could have an additional £750 dividend income at your disposal. 

Enjoy the extra investment income and then ifbthe worst happens then just sell your shares as and when you need the cash.

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