Stating “I don’t need an emergency fund because I have insurance” is indeed a financial fallacy because insurance and an emergency fund serve two different purposes. Insurance is a risk-transfer mechanism that is intended to compensate for large, unforeseen, and often catastrophic events such as a serious illness, a car accident or a large-scale disaster affecting your property.
On the other hand, an emergency fund is used for unforeseen but often smaller-scale personal events like job loss, car repair, or small health issues. It provides you with quick access to cash for unexpected day-to-day emergencies. Relying on insurance alone may leave you with a coverage gap for these smaller emergencies. Additionally, making too many claims may contribute to raising your future insurance premiums.
It’s understandable why someone might fall for this fallacy. When you’re paying for insurance every month, it can feel like an extension of your safety net. After all, it’s designed to protect you financially. However, insurance and emergency funds serve different purposes. Recognizing this distinction guards against a potentially crippling financial misunderstanding.
An effective financial strategy is to maintain both insurance and an emergency fund. Having insurance is critical to protect against large-scale unforeseen events. Concurrently, building an emergency fund reserving at least 3-6 months’ worth of living expenses provides the necessary safety net for day-to-day unexpected events and helps maintain financial stability.
Here are some readings that are informative on this topic:
“Personal Finance For Dummies” by Eric Tyson. Book Link This book provides a deep understanding of various aspects of personal finance, including the importance of an emergency fund.
“Emergency Fund” on Investopedia. Article Link A more in-depth look at the various reasons why an emergency fund is essential for everyone.