Richer by the Day » Why Cash is Still Relevant to Your Financial Plan

Why Cash is Still Relevant to Your Financial Plan

Filed under Carnival, Credit and Debt, Reaction, Saving

In the past, I have advocated building a cash emergency fund. By “cash” I mean a liquid form of money which could be actual currency, but preferably would be savings in a high yield direct bank account. There has been some insightful commentary recently that has caused me to re-evaluate my position and add some justification to it. Of the many posts on the subject, two were my inspiration for this post. In the first one, Mike from four pillars discussed why a HELOC can be used instead of an emergency fund. In the second one, the money gardener explains why he doesn’t need an emergency fund.

In most cases, an emergency fund is really just a method to avoid debt. If a true emergency arose, which exhausted our cash reserves, most of us would just use credit cards, a home equity loan, or a P2P loan. All of those methods are nearly as liquid as cash and easily obtained, with a cost association in the form of interest. An emergency might just be a temporary disruption in cash flow, which taking on extra debt could remedy by buying some time until we can pay the balance off. As someone who always pays off my credit card balance in full, has no non-mortgage debt, and only uses credit cards for the accompanying travel rewards and convenience of not carrying cash, paying a finance charge seems foreign to me. I wouldn’t want to start now, but in a true emergency, I could use credit, in one form or another, as needed.

I may call it my emergency fund, but as it grows, the purpose of my cash fund continues to evolve. The reason is that there is not really an emergency that I would need cash for. I’m in a similar situation to the Money Gardener and don’t really need an emergency fund. My wife and I both have very stable, high paying jobs. Even if one of our jobs were lost, they are the type where we’d probably have a least 6 months before anything was finalized, and even then would get many months severance pay. Also, since we live well below our means, we could cover our expenses on just one of our salaries. Continuing the worst case scenario even further, we have non-cash reserves in the form of stocks, bonds, retirement funds, passive income from P2P lending, and significant home equity that could be tapped as well. As a last resort, our good credit could probably get us a loan to bridge any gaps even before turning to our credit cards which, since we pay them off every month, have a lot of credit available. So clearly I don’t need to stockpile any cash.

Yet I still do. Perhaps my mistake is calling my cash reserves an emergency fund because, as I just outlined, an “emergency” isn’t likely to throw my finances for much of a loop. I like having some cash because cash is certain and it lets me avoid debt. My main reason for building up cash reserves is to handle future expenses and avoid using debt to pay for them. By saving in cash, I was able to put 20% down on my first house, buy my last two cars with cash, and put down nearly 50% on my last house. When it came time to make each purchase, I didn’t have to think about how the stock market was doing recently. I didn’t have to think of the tax implications of selling an asset. I didn’t have to wait for structured investment (like a P2P loan portfolio with periodic monthly payouts) to pay enough to cover my purchase. I simply pulled the trigger, made the purchase when the need arose, without a second thought or regret. Those other investments of mine are great, but cash has its place in my plan as well.

If cash was the only way I held my money, I’d probably be in trouble, but not holding any of my wealth in cash would present problems of its own. After building sizable positions in investment, retirement, and equity accounts, having at least a portion of my wealth in cash is a way to diversify my holdings. If you are on the edge of financial ruin, then a cash emergency fund can help you to avoid catastrophe during a financial emergency. But even if you’re doing well financially, keeping a portion of your assets in cash is still a good idea. Whether you call it your cash fund or your emergency fund is really just semantics. Cash needn’t be king in your financial plan, but it may be wise to at least allow it to have a place in the court.

This post is part of the Money Hacks Carnival #5.