There's a large group of financial advisors who suggest using credit in place of an emergency fund. That way, you can invest your entire portfolio for maximum return (such as in the stock market). This works great during good times, but it can fail badly during times of economic stress--which is just when you need an emergency fund the most.

Having all your assets are invested for maximum return (whether in stocks, bonds, real estate, gold, or more exotic options), makes a certain kind of sense. In case of an emergency, you can charge your emergency expenses on a credit card (or a Home Equity Line of Credit). If the resulting debt isn't too large, you can just pay if off out of future savings, and then go back to putting money into the stock market. If necessary, you can sell investments to repay the debt, but you can sell them at a time of your own choosing, taking into account market conditions and tax considerations.

This strategy has worked fine for the past twenty years, but it fails badly during severe economic downturns--and there's some reason to fear that our economy is heading that way again. And, even if the current economic stresses aren't the beginning of a severe downturn, there will inevitably be one eventually.

Paul wrote last week about UK banks slashing credit limits--in many cases, to the point where card holders have no credit to draw on. The same thing is happening in the US, where lenders such as Countrywide Financial have cut credit limits from 90% of the value of the home to 85%--or even to 70% in southern California and Florida--which means that many people who still had some available credit no longer do.

These sorts of moves are just the beginning. As economic stresses accumulate, access to credit will be cut off for all sorts of reasons. Already things that might just have trigged a fee, such as making a payment two days late, or briefly exceeding a credit limit, are resulting in the account being suspended. I rather expect that lenders will step up their efforts to monitor the borrowers more closely, so that they can cut off credit if someone loses a job or gets arrested. Since there's no formal mechanism for reporting such things, you can expect mistakes to be made--meaning that access to credit can be cut off for no reason at all. It will be restored within a few weeks in those cases, but that's not soon enough, in an emergency.

Of course, some people use credit for their emergency fund not because all their other assets are invested, but because they don't have any other assets. They've been plowing all their savings into paying off debt, counting on the fact that they're adding some breathing room between their balance and their credit limit to use in case of an emergency.

There is inevitable tension between reducing total debt and accumulating some cash for emergencies. In that situation, I suggest accumulating one month's minimum spending in cash, and then going back to paying the debt off as quickly as possible.

The bottom line is that your emergency fund needs to be your money, and access to credit is not good enough. Your emergency fund needs to be in cash, not invested in stocks, real estate, or classic autos. And, at least part of it needs to be accessible in your home town within one business day. It's fine to have part of it in an internet savings account, money market fund, CDs, savings bonds, or t-bills--any investment that can be turned into cash at a specific price in a specific time-frame. But part of it should be in your home town, for those cases where you need it today. Access to credit has worked okay for a long time, but it can't be relied upon when things get tough--which is when you need an emergency fund most of all.