The single biggest danger with a strategy that focuses on liquidity is the risk that someone spends the cash while maintaining the debt. An account with a large sum of unrestricted cash is simply too great a temptation for a lot of people. Maybe they get behind on their credit card bills. Perhaps they want a new flat screen television and think they’ll just dip into the fund and pay it back in a few months. (It never works that way.) If there is any possibility that you are inclined to spend the money on anything other than to make your house payment in the event of an emergency, it’s probably a bad idea. It really comes down to self-discipline and temperament.
Another big danger is the temptation to go for a few extra percentage points of return by investing in riskier assets. This particular financial strategy depends upon safety of principle. For most people, this means highly liquid tax-advantaged securities such as a money market fund that invests in municipal bonds. In exceptional cases, those with highly specialized knowledge of specific markets (such as stocks or real estate) could invest these funds with reduced risk.
