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Keeping an emergency fund in stocks is a bad idea. Read on to see why.
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I’ve been building an emergency fund since my teenage years. Back then, I was maybe putting $20 away here and there since my only job was babysitting, but it was a start.
Since then, I’ve grown my emergency fund significantly, to the point where I now have enough money socked away to cover about a year’s worth of essential bills. And all of that money is sitting in my savings account.
These days, that’s not such a bad thing, seeing as how many savings accounts are paying somewhere in the ballpark of 4% interest. But for many years, my savings account paid significantly less than that. There was a point when I wasn’t even earning a full 1% on my money, and believe me when I say that was frustrating.
Still, I’ve never been tempted to keep my emergency fund in stocks. Here’s why.
It’s a risk I won’t take with my emergency fund
Today’s savings account interest rates aren’t really the norm. Like I said, there was a period where I was getting much less.
By comparison, over the past 50 years, the stock market, as measured by the S&P 500 index’s performance, has delivered an average return of 10%. That’s far better than what you’ll get in a savings account, even today.
But keeping your emergency fund in stocks is very risky for one big reason — you never know when the value of your stocks might decline. And you also never know when you might need to tap your emergency fund without warning.
So, let’s say you build a $10,000 emergency fund and stick that money in a brokerage account loaded up with stocks. What if the value of your stocks declines to $8,000, and you have to pull $8,000 out to cover a sudden home repair? At that point, you’re making that loss permanent. On the other hand, waiting out that loss might allow your portfolio to climb back up to $10,000.
What’s more, your stock portfolio might decline to the point where you’re not even covered for the emergency at hand. Let’s say you run into a $9,000 home repair bill, but your $10,000 emergency fund has fallen to $8,000. At that point, you’re not even able to access all of the money you need, and you’re at risk of having to borrow the remaining $1,000 in the form of a credit card charge you pay off over time.
On the other hand, when you put $10,000 in the bank, the only way it’s not going to be worth $10,000 is if you take a withdrawal. Otherwise, your money is guaranteed to be there, provided your bank is FDIC-insured.
It’s worth earning less of a return on your money
The idea of investing your emergency fund can be tempting, because putting that cash into stocks might grow it into a larger sum over time. But in going this route, you take a big risk. So a much safer bet is to keep your emergency fund in the bank, even if it means earning minimal interest. You can always invest funds you aren’t earmarking for emergencies, but your actual emergency fund absolutely needs to sit in cash.
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