Your Emergency Fund Does NOT “Do Nothing”
I think I’ve mentioned it before, but one of my favorite haunts on the internet is Reddit, and in particular, the Personal Finance and Legal Advice subreddits. The Relationships subreddit is a close second.
Every so often, everyday it feels like, there will be a post along the lines of “is it ok to put my emergency fund in the stock market?”, which is usually followed with the rationale being “I hate having my sitting in an account doing nothing”. I also hear this from friends and family, about how someone they know has too much in savings and that they should invest some of it. Another argument made is that their money in savings is being eaten away by inflation. The second argument is (somewhat) valid, while the first is not. Let me explain.
From what I’ve noticed, this argument comes from those who are impatient and are seeking yield, without paying attention to (or caring about) the risk inherent in investing your savings in a brokerage (a tax-deferred retirement account is a different matter and one we’ll address in a post at a later time).
To address this, we need to define the idea of saving money and the purpose for each savings vehicle. In the US at least, I think there is a misguided view of what “savings” is. When we hear the word “savings” with respect to finances, we think of “retirement”. Understandable, since it’s an idea that’s been beaten into our heads. Retirement savings is one vehicle to save money and it’s simple enough: consistently put some of your earnings in a tax-deferred investment account (401k/IRA/457/SEP), leave it there, and let it grow. After you’ve maxed out all retirement options available to you, put money into a taxable brokerage account. This is what I will call “playing offense” with your money. Increase your money so that, in the future, you’ll have money to comfortably live on.
The legendary Alabama football coach, Bear Bryant, once said “… defense wins championships” and in the realm of personal finance, that is absolutely true. How do you play defense when it comes to money? By having an emergency fund that is 1) roughly 3–6 months worth of expenses, 2) liquid (easily accessed) and 2) shielded from potential losses (other than inflation). Here’s where we circle back to the central conceit that your money does nothing in a savings account. By sitting in an account that’s easily accessible and won’t lose money from any downturns in the stock market, your money is actively protecting you from any emergencies that may happen.
What do I mean? Say you’re a pet owner and you don’t have pet insurance (or maybe you do) and your pet, say a dog, is naughty and swallows a couple of grapes (bad dog, bad dog). Pumping little Rover’s stomach might set you back roughly $250. If you don’t have an emergency fund, chances are you might end up in $250+ worth of debt. It can get worse if the bill is even higher.
One could say that you could STILL pull money from your investments to cover emergencies and that the investments can be liquid (though I argue not as liquid as just using your HYSA). This is where risk comes in, and as I mentioned in a previous post, we as humans really SUUUUUCK at measuring risk. When it comes to investing, we constantly overestimate our risk tolerance. When the stock market is getting white hot and there is a constant stream of media reports about record highs, we want to go ALL IN! Those who seek to invest their savings in the market, operate on the idea that their money will continue to go up (it will on the long term) and don’t properly consider that they’ll have to pull out money from their investments in an emergency during a down-turn (see: current COVID crisis during the initial lockdowns).
Taking that same example of the dog swallowing the grape, while in most situations you might be able to pull it off, if you are doing so in a down market, you might be eating some BIG losses, losses that might have been avoided had it remained in savings.
The desire to see your money grow is a natural and valid desire. Honestly, your money should grow, but it should grow in a way that both protects your future (by playing offence) and protects you in the short-term (by playing defense). How you grow it is ultimately up to you, but please keep in mind that keeping some of your money in savings is a valid strategy!
Do you agree or disagree? Why? Let me know in the comments.
