Picture this: Your clunker of a car is finally on its last legs. You’ve driven that bad boy into the ground and its really time for you to finally invest in a more reliable mode of transportation. It’s all good though because you’ve been tucking away money specifically for a new car. You do your research and decide on a two-year old, gently used Subaru Forester. You want to pay for the car outright in cash, but even after negotiating, you’re about $2,500 shy of how much you had saved up for a new car. Should you just go ahead and raid your emergency fund for the extra $2,500? I mean, what are the odds a real emergency will pop up before you have time to replenish that account, right?
It’s a good question. When is it okay to be raiding your cash reserves?
Use your money for its purpose.
Not all cash reserves were created equally. Nor should you treat your all your savings the same. For example, a retirement savings (e.g. a 401k) should not be getting tapped because it’s time to buy a new car. Sure, you can usually get a cheap 401(k) loan when you’re essentially borrowing from your future self – but have you read the fine print? What happens if you quit to pursue a new opportunity or get fired before that loan is repaid? Often times the entire loan is due back upon your termination or departure.
This is why it’s important to have multiple savings and investment accounts. You want an actionable plan for each one of your short, medium and long-term goals.
If you know a new car purchase is on the horizon, then there should be a dedicated savings account specifically for this purpose. You shouldn’t plan on draining your emergency savings fund in order to pay for the car. If you’re looking to buy a house, then don’t be tapping your 401(k) to cover closing costs or to ante up to a larger property just because you technically could.
Use your money for its intended purpose.
But sometimes it’s okay that you don’t…
All that being said, let’s revisit the original scenario. What happens if you are a little shy of your goal? In the case of the Subaru, I’d rather you raid $2,500 out of your emergency savings fund (assuming you still have some buffer left) to pay off the car outright rather than taking out a loan just for the sake of preserving your emergency savings.
As with all things money, there are exceptions. Let’s suppose you unlock access to a 0% APR auto loan. Then by all means, finance that additional $2,500 on a 0% loan – you aren’t paying interest. Just have an action plan in place to pay it off ASAP.
Should you save to pay off debt then?
Speaking of paying off debt, does it make sense to be saving up your money to pay off debt in bulk or to deplete your cash reserves to ditch your lenders? No and no.
Getting access to a lump sum of money from a tax refund or a bonus and applying that to debt in bulk is different than saving up specifically to pay off debt. Don’t focus on saving to eventually pay it off. Instead, start paying it down now! With a plan of course, such as debt snowball or debt avalanche.
You also don’t want to completely drain your cash reserves for any purchase or debt repayment. It can feel really tempting to just write a big check when you’re tantalizing close to being debt free and you know you have that remaining $1,500 in your emergency fund. Resist the urge. Draining your cash reserves to pay off your debtors can put you in the vulnerable spot of having no choice but to rely on credit if something goes wrong between paying off that debt and rebuilding an emergency fund. And let me tell you – murphy’s law isn’t a cliché for nothing.
Cash reserves are there for your protection and future.
Your cash reserves are part of your overall financial plan. They will be most effective if you are specific about why you have those cash reserves and don’t just build up a buffer for the simple sake of having excess dough. Just always remember: draining and raiding these accounts at will and random is going to prevent future you from being set up for success.