Should an Emergency Fund be kept at all?

[DMat]

If you had a mortgage (or other debt, or just good secure investment opportunities, like one's RRSP), which would you do:

(This isn't a poll because I'd rather hear your reasons than tally opinions)

1) Keep an emergency fund
2) Pay whatever excess funds you have into your mortgage//RRSP and have a line of credit for any emergencies

I'm siding with #2 as long as you are assured that your line-of-credit won't get cut back in the event of a major emergency. I think of #1 as a guaranteed loss of growth to protect yourself against what is supposed to be an unlikely event.

If you choose to do #2, you're spending your emergency fund frivolously, you're just optimally allocating it. If a real emergency hit, you could withdraw on it (maybe not instantly, but if you racked up debt against your secured line of credit, you could just repay it when you renegotiate your mortgage, right?)

Any comments?

[mfd]

I'd rather have hard cash. The last thing I want to worry about is my LOC even if it is secured. I also won't have to worry about servicing the loan which if the rates are high could get quite expensive.

[MGL]

Originally Posted by DMat

I'm siding with #2 as long as you are assured that your line-of-credit won't get cut back in the event of a major emergency. I think of #1 as a guaranteed loss of growth to protect yourself against what is supposed to be an unlikely event.

If you can be certain that your LOC will be there, it's probably a good plan, but the problem is that you can't be certain. The times when you need an emergency fund the most are the exact times when your ability to obtain credit is most in jeopardy and your LOC is most likely to be unavailable. You can use access to credit or saleable assets as a reason to reduce the size of your emergency fund, but to eliminate emergency savings altogether is a risky proposition.

You're right that this results in a loss of growth, but so do many other things. Most insurance premiums, for example, are a likely loss to protect against an unlikely event. Maximizing growth is important, but it needs to be balanced with just a touch of conservative planning.

[CanadianCapitalist]

Originally Posted by DMat

1) Keep an emergency fund
2) Pay whatever excess funds you have into your mortgage//RRSP and have a line of credit for any emergencies

I was of the opinion that #2 was better because of the reasons you point out... In fact, that's what we did when our mortgage was much larger than it is now. But, the problem with this approach was revealed in the current credit crisis. If things get really bad and we do need to tap into the credit line, it may not be there and it may be difficult to get another one. If I were starting over now, I'd go with #1.

The size of the emergency fund will also be dictated by your personal circumstances. If both spouses work, the risk may be lower and a smaller fund may be appropriate.

[FrugalTrader]

Originally Posted by DMat

If you had a mortgage (or other debt, or just good secure investment opportunities, like one's RRSP), which would you do:

(This isn't a poll because I'd rather hear your reasons than tally opinions)

1) Keep an emergency fund
2) Pay whatever excess funds you have into your mortgage//RRSP and have a line of credit for any emergencies

I'm siding with #2 as long as you are assured that your line-of-credit won't get cut back in the event of a major emergency. I think of #1 as a guaranteed loss of growth to protect yourself against what is supposed to be an unlikely event.

If you choose to do #2, you're spending your emergency fund frivolously, you're just optimally allocating it. If a real emergency hit, you could withdraw on it (maybe not instantly, but if you racked up debt against your secured line of credit, you could just repay it when you renegotiate your mortgage, right?)

Any comments?

I think it's a personal decision. It's probably more efficient to take excess funds to pay down debt, but to some, it just "feels" better to have cash on hand. We're a prime example of the latter, we have a mortgage of over $75k, but we hold about $40k in cash.

Mind you, we will be moving some money to pay down the mortgage soon because we have set a new mortgage pay off goal, but to us, having cash on hand feels "safer".

[Rickson9]

Originally Posted by DMat

If you had a mortgage (or other debt, or just good secure investment opportunities, like one's RRSP), which would you do:

(This isn't a poll because I'd rather hear your reasons than tally opinions)

1) Keep an emergency fund
2) Pay whatever excess funds you have into your mortgage//RRSP and have a line of credit for any emergencies

We don't have a mortgage on our personal residence, but we have an emergency fund and a LOC as well.

[Ben]

I would throw my vote behind everything that's been said by MGL, CC, and FT. Collectively, they've covered the point well.

[DMat]

Should one be worried so much about their line of credit getting cut back to such a significant degree, especially if they've built significant equity within their residence that the LoC is secured against?

I thought that, for the most part, people just got their LoC interest rates increased a bit (so far anyways), am I wrong on this?

And I was thinking of the insurance analogy while I wrote the OP. My opinion of insurance is that it's always a poor investment, unless you know that your risk is significantly higher than estimated. But in most cases, it's a necessary evil for immitigable risks (your house burning down).

[Financial Highway]

As CC said in the past I would have also voted for option nr.2 but this credit crisis has illustrated the importance of an emergency fund.
Emergency is the wrong time to get into debt.
Emergency fund is your life line, when life gets though. If you have build a sufficient seize emergency fund and have insured yourself properly you will be able to handle any type of emergency. Without the EF i think you are leaving yourself very vulnerable.

[CanadianCapitalist]

Originally Posted by DMat

Should one be worried so much about their line of credit getting cut back to such a significant degree, especially if they've built significant equity within their residence that the LoC is secured against?

I'll agree that the risk is very low. But it is there. My secured LOC has this statement in bold letters, no less:

At any time, if we ask you, you must pay us the total amount you owe on your credit line.

Granted, you can take other steps, if such an even should come to pass but I've decided that I'd rather sleep well at night knowing there is a small pot of cold, hard, cash stashed away.