What exactly IS an emergency fund?
This money exists for the sole purpose of covering the emergencies that life hands you, allowing you absorb extra unforeseen costs while continuing to maintain your normal life. It is not meant to be used for splurges, such as a new big screen television or a vacation, but rather should remain untouched until you actually need it.
Low Risk, High Liquidity
First of all, in a savings account your cash is highly liquid. If you need money at a moment’s notice, you can simply withdraw it. You may have other investment products that are providing a much higher rate of return, but many of them are not structured for quick withdrawals and can include costly penalties for doing so.
Secondly, a savings account is low risk, which helps ensure that you can count on the full amount to be there whenever you need it. This is why investments with higher volatility- even if they are liquid- are not necessarily viewed as ideal emergency funds; it’s possible they could dip in value at the moment you need the funds.
But what about investing?
In this way, the fund represents a minor sacrifice of returns in order to keep a small portion of your money on hand in a low-risk and liquid form.
What about credit?
First, just because you have a certain amount of credit available to you through your financial institution doesn’t mean this it will always be there. A bank could change their policies, re-evaluate your credit-worthiness, or even change ownership. Any of these events- which are outside your control- could mean that the funds you assume will be available might not be.
Second, in the unlikely event that you experience identity theft, you could experience a serious impact on your credit. This could lead to the loss of certain existing credit cards or lines of credit.
So there are some scenarios where a credit-based emergency fund would introduce certain risks, which undermines part of the purpose of an emergency fund. The aim is to have one portion of your finances designed to have the absolute minimum risk.