I hear this every week with clients: “We do not need an emergency savings account, we have…”:
- Short and long term disability
- Brokerage account with loads of assets
- HELOC (home equity line of credit) we can draw upon when we need it, and it has a great rate.
Let’s discuss this, shall we. There are 3 reasons to draw on your Emergency Savings and I will add a fourth that is really an asterisk.
- Divorce – one of the greatest wealth killers and bankrupters
- Disability – either injury or illness
- Job Loss
* to supplement your Rainy Day Fund ($3k for homeowners) for an unexpected large home repair (e.g. a roof replacement).
Your disability plan may be excellent from your employer and that’s a great benefit to have, but unfortunately, it will not help you with 2 of the 3 Emergency Items. Plus, you may have bills or treatments that are way more expensive than you can afford living on your disability. You may need a driver or childcare. Most disability policies (short and long term) have elimination periods or periods where they do not pay. Elimination periods for long-term disability can be 90 days with some policies. What will you do then?
Unemployment benefits are like disability insurance for losing your job. True, except it will pay pennies on the dollar of what you make now. It’s excellent and you should apply for it if you get laid off, but it is not going to pay the mortgage.
A solid brokerage account is good to have for long-term savings, ONCE you have filled your Emergency, Rainy Day and retirement savings buckets. If you need money fast because the roof caved in or you are suddenly disabled or unemployed, you could potentially have an enormous tax bill if you liquidate brokerage funds.
If you keep a bunch of money in cash or money markets in your brokerage account, that is a different story and it can be used as an Emergency Fund. Money in stocks, mutual funds, bonds, bond funds or any other illiquid asset is not an Emergency Fund. It could be very costly to liquidate it on the day you need it, either due to taxes or the market being down on the day you lose your job (think 2008) or both.
Your HELOC… I love this one. HELOC’s are great to have for many reasons including actually doing upgrades to your home, consolidating credit card debt at a better rate and other strange financial things that come up for regular people, but do not take on debt when either of the 3 Emergencies listed at the top of this article happen.
You do not want to service more debt when you have to buy your spouse out of his/her half of the house in a divorce or have to set up a new household. Cash flow will be tightest then and another debt payment will hurt. The HELOC has to be paid if you refinance or sell the house, which means it will be a big problem if whichever of the three emergencies you are experiencing requires you to sell your home (which happens a lot).
You would not want to service more debt when you have enormous medical bills for a sudden disability. Again, cash flow will be tightest at this point and more debt payments would be unwelcome. You may even need your HELOC for additional medical bills as disability/illness is one of the biggest bankrupters out there.
And of course, servicing more debt when you are unemployed sounds unappealing. Generally, you would cut as many expenses as possible during periods of unemployment.
The cold hard truth is that you NEED TO SAVE for EMERGENCIES. Specifically, the unlikely three events listed at the top. You need 3 to 6 months at least of your monthly household expenses in cash or cash equivalents (e.g. money markets, etc.) to be fully secure financially.