Emergency Savings vs. Debt Reduction
by Derrick Gunter
Recently, much has been written about emergency funds. Anywhere from three to six months income are suggested. And the reasons span from loss of job to unexpected travel to car breakdowns.
The reasons for having an emergency fund can be summed up as "to have sufficient money to buy something that I absolutely need unexpectedly". To accomplish this, it is frequently suggested that money be put away in some type of safe (hence, low interest) account on a monthly basis. This advice is given to people, who like most average folks, such as myself, still have lots of debt.
Debt interest is always higher than safe and immediately accessible income interest. So, this begs the question: Why should I save money in a low interest account when I have debts that have higher interest? Answer: I have no idea.
For people with debt (which includes most of us) it simply does not make sense. Just do the math. No matter when the emergency occurs, you will be better off paying off your (higher interest) debts first, and then saving in the emergency fund.
Debt is incurred because I want something before I have the money to pay for it. As a result, I pay more for the item than its initial cost. Other than a home, and maybe a car, one can usually eliminate the need for this debt by prudent financial management (especially by being willing to wait for what I want). However, by putting money in an emergency fund before paying off my debts, I'm essentially trying to be financially prudent for something that might happen in the future, when I have not yet finished correcting my financial imprudence of the past.
I suppose it could be argued that the reason for the emergency fund is to ensure that there is untouched hard cash ready and waiting for an emergency, so that no matter how bad I mess up the rest of my financial life, my emergency cash will be there for me. So, just in case I give in to my wants and use up my debt just after paying it off, I'll still have the emergency fund. But not even this makes sense since it essentially amounts to being financially prudent in one part of my life, just in case I am financially irresponsible with the rest of it.
It is wise to have access to money with which you can handle an emergency, but it should not be done at the sacrifice of existing debt.