Imagine for a moment all of the possible scenarios that would require you to withdraw thousands of dollars in cash at a moment’s notice from a bank account. Paying a ransom? Bailing someone out of jail? Unless you can think of a specific reason in your life to need thousands of dollars at your fingertips, keeping an emergency fund in cash is ridiculous, for several reasons.
The main reason not to keep a cash emergency fund is actually purely psychological — ease of access makes it too tempting for many people to take funds out for things that aren’t true emergencies. A minor car repair or doctor’s visit may be unexpected, but using average past expenses as a guideline (you are tracking your expenses, right?), this should be budgeted for. Paying off your credit card bill after accidentally spending a little more than you earned means immediately tightening your belt so you can cash flow the payment before the due date, not tapping an emergency fund.
Aside from that, it is important to consider that in today’s world, almost everything can be paid for with a credit card, which provides a grace period of 25-30 days to pay it off interest-free as long as you weren’t carrying a balance (but be sure to pay it off). Even in the very rare instance that a cash payment is required for a true emergency, many banks will allow you to set up a line of credit (depending on your creditworthiness) that will allow you to take a withdrawal at any time. Capital One 360 checking offers an “instant overdraft” feature that allows its checking account holders to instantly borrow up to $1,000 at around 10% interest per year. If you can pay this off within a couple of days after selling some investments, your interest payment will be pennies.
The most important reason to not let your emergency fund languish in a savings account earning almost nothing is the ability to earn a higher rate of return! The primary purpose of an emergency fund while you’re still employed is to ensure that your core expenses can be met in the event of a job loss. Be sure to account for unemployment benefits and other sources of income when determining the right amount to hold. This e-fund amount should be held in a low-risk investment, like government bonds, or even the Vanguard Wellesley Fund which regularly returns 6-7% per year and only lost 9% in 2008 (when the stock market lost nearly half its value). If you needed to take out your e-fund in 2008, in the middle of the worst recession in a generation, you would have only lost 9% (assuming you bought in right before the crash).
So don’t panic about keeping that cash under the proverbial mattress. Let your money work for you! Once you have invested more than your target e-fund amount, you can invest the remainder more aggressively.