Should cash be part of your emergency fund?

This post is by staff writer Honey Smith.

When I was in college, one of my co-workers at my part-time, on-campus job gave me a funny little gift that I use to this day. What was it? It’s called a “wallet fairy.” According to the note that came with my little talisman, you put it in your wallet and “you’ll never be out of money when you need it.”

I can’t honestly say that the “magic” has been foolproof. I believe I’ve mentioned on a couple of occasions the time I didn’t wash my hair for a month because I couldn’t afford shampoo. And I distinctly remember crying after going to the grocery store on a couple of occasions because I didn’t know how I was going to pay my bills after buying food. But I guess if the magic were foolproof, this fool wouldn’t have learned her lesson and started digging her way out of debt, right?

But you know what? National Preparedness Month (a.k.a. “September”) may be over, but it’s always a good idea to consider your plans if an emergency occurs. And after the flash flooding we saw this year in Phoenix, I am thinking a lot more seriously about what it would be like to be out of money when I need it. I’m starting to think that it’s important to keep cash readily available, but I wanted to really sort out why and how much and where. So here goes….

Should you keep an emergency “cash stash”?

To be clear, I’m not talking about keeping an extra $20 in your wallet (not that that’s a bad idea). I’m talking about keeping a significant amount of cash on hand in case of emergencies — in the hundreds or thousands of dollars. Here are the pros and cons for doing so that I can think of:

  • Pro: Out of sight, out of mind. Even if you put your emergency fund in an online-only account such as Capital One 360 (formerly ING), at least it’s there. You receive bank statements reminding you of its presence. Maybe it factors into your Mint net worth. Stashing actual physical money somewhere out of the way means you are less likely to think about it (and thus, be tempted to spend it) unless there’s a true emergency.

  • Con: Not earning interest. If you invest your money, you are (hopefully) earning interest faster than inflation can erode the value of your cash. The “common wisdom” is that inflation is about 3 percent annually, so you should aim to beat that benchmark, taking into account things like diversification and your own risk tolerance. Even parking your cash in a savings account with their interest rates of 0.95 percent or less (based on this week’s savings account rates) is better than nothing, right?

  • Pro: Peace of mind. Cash can’t be garnished like a paycheck or bank account, and it isn’t easily traced. For some people, having access to money that flies under the radar, so to speak, may make them feel more secure.

  • Con: If it’s gone, it’s gone. See above: Cash isn’t easily traced. If you lose the money, it gets destroyed, you are robbed, etc., you may have very little recourse.

Are there other significant pros and cons to having cash on hand that I am missing?

How much should you keep?

Assuming that you’ve decided keeping some amount of cash on hand is best for your particular situation, the next question becomes: How much cash, exactly, should you keep? A solid emergency fund may be three to six months’ worth of expenses, but that is probably more than most people are comfortable keeping in cash. Not to mention, even at sub-one-percent interest rates, when you start getting into the thousands of dollars, you start missing out on a decent chunk of change.

The logical question to ask yourself at this point is, What emergency situations do you think would require physical cash? For example, if you live in an area that is prone to natural disasters, keeping enough cash on hand to buy food and supplies in the event that credit/debit isn’t an option (due to a power outage or what have you) may be smart. It’s important to be realistic, but there’s no need to be paranoid.

Where should you keep it?

I suppose theoretically, you could keep it anywhere. However, if you want to make sure that you’re the one who is actually keeping it, your main options are likely these:

  • In your home, in a diversion safe. A diversion safe is something that looks like an ordinary household item or product that actually is used to hide items of value. Diversion safes might look like books; cleaning chemicals (think a can of Ajax); cans of soda, water, or food; or even toiletries (think a can of hairspray). The pro is that diversion safes are relatively inexpensive, but most don’t actually require a lock to open. So if someone does happen upon it, the gig is up. Diversion safes also tend to be relatively small, which may be a pro or a con depending on your needs.

  • In your home, in an actual safe. A real safe is usually larger and can thus accommodate more items, if you have other valuables besides cash that you’d like to protect. It may require a key or combination to open (some are even biometric!) and, unlike most diversion safes, many are fireproof/waterproof or fire/water resistant. Accordingly, they also take up more space, are difficult to hide, and may be expensive.

  • In a safe deposit box. For a rental fee, your cash, other valuables, and important documents may be stored in a bank, post office, or other institution. The fee is usually fairly minimal for most needs, and you have the reassurance that most institutions offering this service are under some form of guard 24/7. However, that does mean if you want to access the contents of your box, you must leave your house. Depending on the circumstances under which you need to access your cash, this may or may not be feasible. After all, when was the last time you went to the bank?

There may also be indirect costs when storing items at home. If you have large amounts of cash or valuables, you may need or want a robust alarm system, for example, and that may entail an up-front cost and/or a monthly subscription.

Like most aspects of personal finance, I suspect that opinions on this topic vary widely. Do you keep physical cash? Why? How much cash is too much? And how do you balance issues of accessibility with the desire to keep your money safe?

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