A Contrarian Take on an Emergency Fund
Personal Finance and Emergency Funds go together like March and a Busted NCAA Bracket - you can’t have one without the other.
So, imagine my surprise when scrolling the socials, I found this video explaining why an emergency fund is pointless.
A spicy take.
But not necessarily a dumb one.
His alternative? If true disaster strikes, pull contributions from an IRA.
Pull from an IRA??
A VERY spicy take - but is it a good one?
His case against the emergency fund is two-fold:
- Most People Don’t Experience Major Financial Emergencies: Only 36% of people experienced a true financial emergency in the last year with most averaging under $1,000
- You Can Always Pull from your IRA: Contributions (not gains) can be withdrawn tax and penalty-free
Those facts are pretty compelling.
But they may be misleading.
Most emergencies, like car repairs and vet bills are around that $1,000 range.
But no way he’s pulling IRA money for every car repair.
He’s likely got extra cash on hand to manage the smaller scale ‘emergencies’.
So we're talking big emergencies.
If you get laid off and it takes you 4 months to find a job, you’ll need $10-$25k+ to cover living expenses.
That makes the IRA approach a bit harder.
Two Main Risks I See
1.Once you withdraw, you can’t put the money back in.
That’s right. No undo's. You can’t put that money back in because you’re still subject to the $7,000 annual contribution limit.
So, that drawdown will cost you the opportunity cost of tax free compound growth into retirement. That can be hundreds of thousands in lost growth.
2. IRA Investments Tend to be Volatile
Most IRA investments are in aggressive index funds.
50% swings on those funds are fine in the long term.
But if the market is down when you need the money, you’re forced to sell at a loss instead of waiting for a recovery.
So, do I keep an emergency fund or not?
The core question you need to answer is this:
Does the potential growth from investing your emergency fund outweigh the risk of needing it when markets are down?
If you’ve got great investing discipline, strong job security, and a higher risk tolerance, the IRA approach could work.
But for most, it may make sense to take a hybrid approach.
For example, keep 3 months of essential expenses in a money market account or high yield savings account while investing any additional money.
That way, you get both security and long-term growth while minimizing the risk of market volatility.
