When I first started studying personal finance I couldn't help but look at it in a way that everything had to be perfect. By nature, I'm a perfectionist and super analytical.
If I could earn 0.05% more in a different savings account, I'd move my money. If I had two debts to pay off, one with an interest rate of 4% and one with 4.1%, I'd always pay the 4.1% off first.
This is why I used to find myself at odds with @daveramsey snowball approach. In my head, there was no way it made sense to pay off a debt with a lower interest rate just because it had a smaller balance. Mathematically, it typically makes the most sense to pay off the highest interest rate debt first, so that's how I approached debt.
I studied Dave to understand why he had this strategy. It wasn't about money at all. I realized it was about human psychology, and that's when it all changed for me.
I realized the difference between Dave's snowball method and the "optimal" approach was immaterial and so tiny that the psychological benefit of the snowball method far outweighed the financial gain from the more "optimal" approach.
I had been using an emergency fund strategy I created (I think) for years. I never put much thought into WHY it worked, I just knew it did. Then it all came full circle. Human psychology.
Why shouldn't your emergency fund be in just cash? Human psychology.
MY STRATEGY: pay ahead any debts you may have. If you have a car loan, pay it ahead 2-3 months. A mortgage? Pay it ahead. Student loans? Pay them ahead.
It still provides the cushion if you enter an emergency because you won't have to pay those debts for 2-3 months, yet you won't have a huge lump sum of cash sitting in your bank account teasing you and testing your emotional strength.
This doesn't mean to keep no cash in a savings account, definitely still keep a decent amount of cash in savings too, but ALSO pay ahead your loans.
All the best,
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Good thoughtful article. I like the examples or insights on how to optimally utilize savings esp. if one has loans to payoff. I personally prefer to have some level of cash as emergency fund. However, I agree with your view w.r. to consumer loans - credit cards, car loan, etc where interest rates can be high or length of the loan quite is short. Assuming one doesnt have consumer loans I believe one should be happy to save up or hoard some cash aside in savings, which could come in handy for any rainy day or in future if you decide to payoff mortgage, student loan, etc.
Great thoughts