The longstanding school of thought on emergency funds is that they should be held in savings accounts, short term CD’s, or money market accounts in order to access them quickly.
With the speed of brokerage firms today, I can sell stock and have funds in my account in just a few days. Would it make sense to keep a portion of my stocks that I have held for the long term and earmark them to sell when and if emergency funds are needed? You would need to keep the tax implications in mind, but this would seem to garner the benefit of a better investment return and still have money quickly if an emergency arises.
The temptation to invest your emergency fund is strong.
We, “financial wellness” folk, advocate for you to gather up a bunch of cash for an emergency fund and then do virtually nothing with it. “Keep it safe and liquid,” we say. “A saving account is your friend,” we’ll implore.
But, just look at that money not gaining any interest. You were so responsible to get it saved up and set aside. Now, it seems almost irresponsible to not do something with it. I get it. I’ve had those feelings, too.
I think it’s important to remind ourselves what the purpose of an emergency fund really is. First and foremost is meant to keep you from being forced to make a bad choice. Picture this. You’re driving home from work on a Friday afternoon. The sun is out. It’s a very comfortable temperature outside. The windows are down and your favorite song starts making its way from the stereo speakers to your ears. Just as you finish the last lick in the (air) guitar solo, your car announces that it is greatly displeased and you pull to the side of the road. You’re stuck. It’s either the transmission, a tire, your exhaust fell off, or the flux capacitor broke. You don’t know because you didn’t take auto mechanics in high school and you can only watch so many YouTube videos. But, whatever it is, you aren’t going anywhere. You know there’s a problem, and it’s going to be expensive. You know it.
You were right. Your car gets towed to the shop and they let you know that it’s going to be $3,200 to take care of the issue. But, if you don’t want to be back there soon, another $1,000 in preventative maintenance is required.
Now what? Well, if you have the emergency fund in a boring saving account, you can rest just a little bit easier. Oh, it’s still going to stink paying for the repairs, but it didn’t impact anything else in your life. You’ll have a repaired car and you’ll start building up the emergency fund again. Boring, but that’s not a bad thing in this case, is it?
What if you had decided to invest some/all of your emergency fund? Maybe the investment has done well and you’ve got more there now than what you invested. “Perfect! That’s how it’s supposed to work.” Nice job. You win this round.
If the market has decided to perform like your car, though. You might be in a bit of trouble. Not only will you feel the stress of possibly still needing to come up with the money (Visa/MasterCard to the rescue…), you’ll also have to deal with coping with an investment losing money and being forced to take the loss.
That isn’t what emergency funds are for. Keep your minimum cash available in a stable and liquid place. A saving account is your friend. However, if you want to keep saving after that account has been established, absolutely consider opening an investment account for that money. Let’s replay the above scenario with this option. The car takes a dump, you go to the emergency fund to take care of the expenses, and you could replenish the emergency fund with the investment account if/when the timing is right from the investment account and your monthly savings. Man, that feels like a plan!
When it comes to emergency funds, Dave, don’t try to out think the room. Keep a good amount of money in cash ready to go and then build around it with investments as the opportunity arises. You’ll be strumming along with your favorite tune again in no time.
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