A few months back when I wrote about how our small emergency fund saved us, No Debt Guy commented on how having an emergency fund in cash may be counterproductive. Here is what he said:
I have often wondered if having an emergency fund is the best way to pay off debt or is it counter productive?
For example if you are carrying at credit card balance of $2,500 and have $2,500 in your emergency fund you would be better off paying off your credit card and rebuilding your emergency fund.
What if you have an emergency? You can still take a cash advance from your credit card and you are no further ahead.
This does take some serious discipline, but you will save interest costs.
He does make some interesting points. However, I feel that one needs to be SUPER cautious with that type of system.
Most of you are probably in some type of debt. It’s why you’re here. You’ve probably overspent with credit cards and bought things that you didn’t need. I know I have. So, shouldn’t your main goal to be rid of credit cards forever? Like Dave Ramsey often says, “no one EVER told me they got rich by using credit cards”. I have to agree with that point. When I was using my credit card that gave me cash back, all I could think about was hitting that $50 mark so they could send me a check. So, I would spend more money to earn 1%-3% back. Talk about counterproductive! There was no way I was going to get rich by playing that stupid game.
So, I figured I would come up with a few reasons why it may be counterproductive to use a credit card (or any other line of credit) as an emergency fund. Here are some things to consider:
You May Redefine What an Emergency Is
It’s been said before that using a credit card makes you susceptible to spending more. So, wouldn’t using your credit card for an emergency be the same thing? If you car breaks down and you only have $1,000 to fix the problem, wouldn’t you shop around? I know I would. However, if I were using a credit card I would be more likely to just give in to the initial price and pay it. It’s only on a credit card, right?
I think you may also redefine what an emergency fund is. For example, would you typically use your cash emergency fund to pick up a small amount of groceries if you are out of grocery money for the month? Probably not. But if you have that credit card to fall back on, you might just head to the store when you may have some things to eat at home. If you are like me, you would probably pick up more items too!
You’ll Miss the Experience of Paying With Cash
Most people say that it’s harder parting with cash than it is using a credit card. I’m a little more skeptical but I still think it’s true. However, I think having a cash emergency fund makes you learn to handle money better. I mean, you got into credit card debt by using credit cards. How is still using a credit card in emergencies going to make you any better at handling money?
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Personally, I love having a cash reserve. It just makes me sleep better at night knowing that I can actually hand someone cash if I have a financial emergency. Handing them a piece of plastic would be much harder to handle knowing what I’ve been through financially.
How about you? Cash or credit?