As part of the pros vs cons debate series, I’ll be tackling a classic question in the personal finance world: Do you really need an emergency fund?
You can consider this question with the same perspective that you would use when answering the question ‘do you need insurance?’
You know the answer is yes, but while you are young and still think you are invincible, you default to thinking you don’t need it.
Your like, what could possibly happen?
It’s hard to plan ahead for the unexpected. Especially because you think the events that an emergency fund would protect against will never happen.
So it’s easy to never take the steps to secure yourself financially against these “unlikely events”.
BUT deep down we all know random things happen all the time. And its those random events that cause you to draw down on your emergency fund.
Think of those Allstate commercials with the mayhem guy.
For example, shortly after I moved into a new neighborhood, I came home and found the back window of my car had been shattered by someone or something throwing a rock into it….
I was definitely surprised. But it happened. and I had to get it fixed – totally unexpectedly.
Now you may be wondering what this has to do with investing?
Investing comes with an inherent set of risks because unlike keeping your money in a savings account, the money you invest is not guaranteed to go up or even stay the same.
Instead you face the real risk of losing money with the tradeoff that you could also gain much more money than you could by keeping it in a savings account.
This is what’s known as the risk vs reward tradeoff.
So, do you need an emergency fund before you start investing?
My answer is YES!
Before you seek the higher returns available in stock investing, you want to be sure that your foundational expenses can be met, if something unfortunate or unexpected happens.
you want to have your emergency fund established before you leap into the world of investing.
The reason is that an emergency fund is just one of several foundational personal finance steps that you should have in place before you begin investing and trying to grow your money.
If you choose to skip the emergency fund, when an unexpected event occurs, you will have to liquidate some existing investments to get cash.
Unfortunately, that action could trigger short term capital gains or other tax consequences if you end up selling stocks that you held for less than a year.
Conversely, an emergency fund holds liquid funds that you can access easily and immediately.
You can get this liquidity by keeping your emergency funds in a money market fund or high yield savings account (money market account).
The good news is that once you have your 3-6 month of expenses accrued, then you can invest the remainder of your disposable income without guilt and with the assurance that your base necessities are covered.
The interest will be low, but you won’t run the risk of losing money or of the account balance dropping due to market fluctuations.
Now that’s peace of mind.