Should you invest your emergency fund?
I was online checking out the financial conversation that was happening and stumbled upon a post from someone that claimed that it’s a good idea to invest your emergency fund.
There was plenty of back and forth with people agreeing and disagreeing. In this article I want to address the concept of an emergency fund, why you should have one and what you should do with it.
First, what is an emergency fund and what is the purpose? You know how commercial buildings will have a fire alarm pull switch that says, “in case of emergency, break glass”? That’s what the emergency fund is for. It will not stop bad things from happening, like the building catching on fire. But, it hopefully will mitigate the damage like the alarm where everyone gets out safely and the fire department arrives on the soon quickly.
So when life is really kicking you while you are down(that does happen in life) you have some easy to access money to help mitigate some of the damage and recover faster. So logically, you would want money that you keep in an emergency fund to be easily accessible and available when you need it.
This is generally done with a bank savings account or money market account. Why? Because those accounts don’t fluctuate in value. They pay a little interest on your balance but the balance is not going up and down like the value of stocks will. So that begs the question, should an emergency fund be invested in stocks?
This is a pretty dangerous concept for most people. In theory you may avoid getting burned if you have your emergency fund invested in stocks, but in reality you will likely get burned. Stocks are volatile. Over long periods of time they tend to increase in value. But in shorter periods of time they can go up and down at pretty rapid rates. So what happens if you need your cash during a time of market turbulence and the $20,000 you had set aside for emergencies is now only worth $15,000? That is a very real risk.
Having cash available is a powerful tool to help you navigate potential emergencies and help you sleep better at night. With that said, there is such a thing as being too heavy in cash. That number can be very different for different people but there is risk in sitting too heavy in cash. And in fairness that is probably what that post was about that sparked this article.
Traditional advice says to keep 3-6 months of your expenses in your emergency fund. This is a great guidance. Some situations may be able to get by with a little smaller emergency fund while others may need a little larger fund. You need to take your family situation, income stability, risk tolerance, and other life circumstances into account to arrive at a clear number for you. But one thing is clear, once you have that money set aside for emergencies, make sure you are investing your long term savings beyond that!
Its good to invest, I want you to invest, just don’t invest your emergency fund.
Phil Francois, CFP®
Owner & Financial Advisor
https://www.foundationwealthplanning.com/