People treat an emergency fund as some kind of ace-in-the-hole when it comes to financial difficulty, but it is only one of many sources of money that you can utilize.
What is an emergency?
First, you have to define what an emergency is. Is it a lost job? Is it an unplanned event (pregnancy, perhaps)? Is it a medical emergency? Is it the death of you or your spouse?
Also, what does it mean to be unplanned? Is being so unhappy with your job that you give a 2-week notice an emergency? Is one month of planning an emergency? Two?
Only you can answer these questions for yourself, but they significantly shape your financial strategy. Planning is highly dependent on your cashflow, and, for some people, it may take them a year to build enough savings to enable them to take 3 months off work. For others, they may be able to change their spending to build up enough for 3 months in 1 month.
Also, you have to consider the length of the emergency. Job-loss is rarely permanent, but it's rarely short as well. The current average is 30.7 weeks: that's 7 months!
Money in an Emergency
There are six main places that people get money during a financial emergency:
- Savings accounts (included in this is CDs or other guaranteed financial instruments)
- Investment accounts (stocks, bonds, etc.)
- Secured debt (Equity loan)
- Unsecured debt (credit cards, LoC)
- Supplemental income (Social security, unemployment, side job)
A good emergency strategy takes all six of these into account. Some emergencies may lean more on one source than the other. However, some of these are correlated.
For example, in 2008, three things happened: the stock market crashed, unsecured debt dried up, and people faced financial emergency (lost jobs, cut wages). If you were dependent on a stock portfolio and/or a line of credit, you'd be up a creek, because the value of your investments suddenly decreased, and you can't really tap your now significantly limited line of credit.
However, if you had a one or more of cash savings, unemployment income, and unemployment insurance, you would probably have been OK.
Budgeting for an emergency
When you say "financial emergency", most people think job loss. However, the most common cause of bankruptcy in the US is medical debt. Depending on your insurance situation, this could be a serious risk, or it may not be.
People say you should have 3x-6x of your monthly income in savings because it's an easy, back-of-the-envelope way to handle most financial emergency risk, but it's not necessarily the most prudent strategy for you.
To properly budget for an emergency, you need to fully take into account what emergencies you are likely to face, and what sources of financing you would have access to given the likely factors that led to that emergency.
Generally, having a savings account with some amount of liquid cash is an important part of a risk-mitigation strategy. But it's not a panacea for every kind of emergency.