Emergency Funds: Cash vs. Credit

by Tax Guy - Burlington Accountant on June 16, 2008 Print This Post Print This Post

I‘ve always viewed the emergency fund as a self funded insurance policy designed to protect me and my family from unexpected expenses or to cover us for a period of time should my employment be interrupted.  The only real differences between risk based policies sold by insurance companies and a self funded policy is that with self funded policies your premiums stop once your policy is fully funded, your premiums are not jacked sky high if you make a claim, and your funds are accessible at any time for any reason.  Like any insurance policy you expect to access the funds when an event triggers the policy to pay out and with a self funded policy you must ensure that you can get access to your funds in a reasonable period of time.

Once enough has been saved for the emergency fund, many people choose to keep these funds in savings accounts, money market funds, treasury bills, or even certificates of deposit.  My question is why should these funds remain in very short-term instruments that have such low returns when you already have a line of credit as an emergency fund?

By keeping emergency funds in savings accounts or short-term investments your capital is tied up capital in low rate of return investments.  With the effects of inflation, you run the risk of having the purchasing power of your emergency fund actually decrease over time.

An Alternative: Line Of Credit & Cash Invested

If you need to establish an emergency fund, why not set up a line of credit as your emergency fund and then systematically invest your contributions into mutual funds, stocks or bonds?

The contributions should be treated like an insurance policy premium and made regularly.  The investments will be subject to the market and should generally earn better returns than savings accounts or CD’s.  If you have a short term cash need, draw from the line of credit and pay it back immediately.  If you emergency need is longer-term you can cash in your investments and pay the line of credit.

The Risk

Since the investments will be in variable return securities, there is a down size risk that the market may go down and your investments may lose value.  However, if you plan for a market decline in your investment strategy, you can hedge that risk as well.

About The Tax Guy...

Dean Paley CGA CFP is a Burlington accountant and financial planner who services individuals and business owners locally, nationally and internationally. Dean has appeared in the National Post, Toronto Star and Metro News.

To find out more, visit Dean's website Dean Paley CGA CFP or connect via Twitter @DeanPaleyCGACFP.

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Philip Brewer June 20, 2008 at 8:14 am

The problem with relying on credit for your emergency fund is not the extra risk that you’re taking with your investments, the problem is that no ordinary lines of credit available to customers are guaranteed.

If your situation takes a downturn–the value of your house goes down, you lose your job, you run up a bunch of medical bills–the bank that offered you a line of credit can (and will) cancel it. The situation is doubly bad, since that’s exactly when you’re likely to need your emergency fund.

I wrote an article on the topic here:


Thanks for the link to my “Things to insure” article!

PMT June 20, 2008 at 10:58 am

Good point and I agree the bank can cancel the line of credit. That is a real issue right now. But if you have enough equity or a small enough mortgage it’s still a reasonable option.

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