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Emergency Funds: Cash vs. Credit

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 [1], 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.