Coronavirus is a perfect example of why we should have an emergency fund. For those who don’t have an emergency fund, this will be a painful lesson.
In a booming economy, it is not exciting to talk about emergency funds. We would much rather talk about investing in stocks, real estate or borrowing money to increase our return on investment (because it’s so cheap to borrow right?).
But today is different. The coronavirus is rapidly spreading around the world. More than 100 countries have introduced travel restrictions. Jobless claims have hit new records and many major stock market indices have dropped more than 20%.
There is no doubt that we are in an economic recession right now. Those who have lost their jobs or faced a salary reduction know that the recession is real. Others may continue working from home without feeling the immediate impact but will feel it soon.
We might have the illusion that this will stop in a couple of months, but it is highly unlikely. The reality is that we just don’t know exactly what will happen next and we have to be prepared for the worst-case scenario.
Pile up Cash
In uncertain times like these, many of us want to feel safe. Of course, the first priority is to stay healthy. The second is to make sure you and your family can survive this recession financially.
If you don’t have a solid 6-month emergency fund, you should focus on piling up cash. Avoid buying any luxuries for the time being. Postpone large purchases, such as a house or a new car. It’s also a good time to sell stuff you don’t use often to get some extra cash.
Also, there is no need to prepay debt at this point. Just keep paying your monthly repayments. Liquidity is way more important right now because you can’t foresee many potential risks. And the likelihood of these risks has skyrocketed due to the coronavirus.
Some risks include:
- Losing your job – highly likely with an economic downturn
- Losing the passive income that you were counting on (e.g. tenant not paying their rent)
- Medical bills
- Divorce – some speculate that due to coronavirus and self-isolation the divorce rates will skyrocket
- The most dangerous – the risks that you don’t know yet
Don’t Invest Your Emergency Fund
If you have an emergency fund saved up, well done! But don’t try to be clever and invest it right now. Your emergency fund is meant for reducing risk, not earning a financial return.
You should not invest your emergency fund in bonds, stocks, ETFs, cryptocurrencies or anywhere else, even if it’s a low-risk asset. Any amount that you invest from your emergency fund, even at very low-risk, has the potential to lose value. In a market downturn, you are more likely to have emergencies and your savings will lose value at the same time – hardly an ideal situation!
When you have cash, you are in charge. When you’re dependent upon your ability to borrow the cash you need, the lender is in charge.
At this time it is safe to say that cash is king! More importantly, it is liquid cash that matters.
Your emergency fund is for reducing risk, not earning a financial return.
Best Place to Keep Your Emergency Fund?
The simplest and best way is to put your money in a separate bank account (checking/current) that you are not using for your daily purchases. You need to keep your money separate, but easily accessible when an emergency occurs.
I keep my emergency fund in a bank account that has no debit card linked to it. In case of an emergency, I can transfer that money within seconds to another bank account (within the same bank) to which my debit card is linked to. Just make sure your limits are set right so you don’t face any liquidity issues.
Of course, by keeping my money in a bank, I am betting that my bank will not go bust and I will be able to use my emergency fund.
What If Your Bank Goes Bust?
If your bank has a bad reputation and you feel that it might go bust, then I suggest you change your bank. Even if your money is protected by guaranteed deposit insurance ($250,000 in the US or €100,000 in the EU) you will not get your money back very quickly – it can take months.
If you don’t trust banks as a whole, you can keep some part of your emergency fund in physical cash. Personally, I keep a very low % in physical cash (about one month’s worth of my expenses) because it also has its own risks. You can lose it, be easily tempted to spend it on non-essentials or someone can steal it from you.
Overall, for everyone, this ratio will be different. Some will hold 100% of their emergency fund in a bank account, some will have a small amount of physical cash set aside and some will have the majority of their emergency fund in physical cash as I have seen. It is your decision to assess your own risks and financial situation and make the best financial decision.
A Painful Lesson
In a Bloomberg interview on 31 March 2020 Nassim Taleb said that the COVID-19 is not a black swan (a rare event that comes as a surprise). He and many others warned us a long time ago that there is a high risk of a pandemic, such as COVID-19. But we were ignorant and didn’t listen. We were caught up by the booming economy.
This, in a way, is a perfect example of why you should have an emergency fund. Also, it is a perfect example of why it should be liquid! Stocks go down and liquidity tightens. Cash is your best friend at the moment. If you have an emergency fund right now, you can also avoid additional debt.
It’s not easy to build an emergency fund in a booming economy because we all experience lifestyle inflation:
- Everyone else has debt
- Everyone else has a credit card
- Everyone else has a car payment
- Everyone else does not save money
- Everyone else has this thing that you want as well
For those who don’t have an emergency fund, this will be a painful lesson, but hopefully, as a result, you will make better financial decisions when it comes to your money habits in the future.
When the next financial crisis comes, don’t be everyone else.