Emergencies Versus Opportunities

Tim writes in:

We are working on our emergency fund. We put almost all of our extra income into the fund. The problem that I am wrestling with is that it is hard to watch opportunities go by while we work on this fund. It will take a year or two to fully fund our emergency fund (3 to 6 months). Example, I really wanted to buy some Ford stock when it was at $4 / share. I was pretty sure that over the next year it would do well, but it is a risk and at the time we were starting our fund. It has hit $12 per share in about a year. I know there will be other opportunities like this, but is hard to watch a missed opportunity.

Do you think the emergency fund should be fully funded before buying opportunities?

I’ve received several emails like Tim’s over the last year and they all point to the same thing. They all feel that putting their money into emergency funds equates to losing opportunities in other avenues of life. In Tim’s case, for example, the money he put into his emergency fund would have done much better for him had he put that money into Ford stock.

There are several points worth making here.

First, hindsight is 20/20. I can’t tell you the number of times I’ve lamented the fact that I didn’t buy any Google stock near the IPO. I told everyone I knew that it would be a big winner. I knew with every core of my being that it would be huge. And it was. I now look back with a sense of missed opportunity. Why didn’t I throw every dime I had into it?

Here’s the thing, though. It only feels like a missed opportunity because I now know what exactly happened to GOOG. Back in the day, I didn’t have such knowledge. I had no way of knowing whether or not Google would shortly be supplanted as the 800 pound gorilla of online search, just like they had replaced Yahoo! and Yahoo! had replaced Altavista, all within about a six year stretch.

Just because I now know it was a winner doesn’t mean that it wasn’t an enormous gamble at the time, one that, if I really step back and look at it honestly, I’m glad I didn’t take because the total risk wasn’t worth it.

Looking back at “what-ifs” as a justification to push your finances is always a bad idea, because it distorts the real picture of your investing skills. You remember the guesses you made correctly and tend to gloss over the ones you missed.

Second, emergency funds are about as unglamorous as can be. CNBC doesn’t breathlessly talk about how people are putting 5% of their paychecks into cash emergency funds. Instead, they’re glamorizing the stock picks of the week. Jim Cramer doesn’t throw chairs and yell about an automatic savings plan, after all.

CNBC (and most of the money press) promotes and sells and glamorizes a certain flavor of entertainment and lifestyle – the “big investor” lifestyle, as I like to call it. Why do you think there are tons of commercials for Escalades and the like on there? It’s because the “big investor” lifestyle is sold as being glamorous – and the marketing to people who are into that also goes heavy on the glamour.

Thus, when we think about investing, we don’t think of savings accounts as fun and exciting, but quite often that association is made with stock investing. A big part of that is the fact that there’s a lot of money to be made from people investing in stocks in the form of fees and commissions, while the same isn’t as true of savings accounts. The marketing dollars go toward glamorizing stock investing.

Third, the financial benefits of an emergency fund aren’t as easy to see as the benefits of other investments. All you have to do is glance at a stock ticker to see the benefits of a stock investment and, during a bull market like this one, the proof seems to come up all the time. “Look at all the money people are making,” people tell themselves, and that’s why people often invest near the top of a bull market.

On the other hand, the real benefit of an emergency fund is unseen in our day to day lives. We can’t see the unexpected. Our emergency fund doesn’t help us at all on a normal day, but a glance at that stock ticker tells us that we might have made a bit of money if only we had invested in stocks.

It’s on the abnormal days when our emergency fund helps us. It saves us from going into debt to cover a car repair – a debt that will come with a hefty interest rate. It saves us from racking up big credit card bills. It protects us from a job loss.

But our minds work in an interesting way. Once we make our way through those unfortunate events, we tend to forget about them and gloss over them, putting them into the past and not thinking about them any more. Most of the time, we move on from those rough events. It’s how we’re able to deal with our day to day lives. (I covered this idea in detail before.)

As a result, we think our lives are more even than they really are. We gloss over those big bumps in the road and see our path as being much smoother than it actually was. Thus, we don’t see the real need for an emergency fund anywhere near as clearly as we ought to, and compared to other opportunities that run up and slap us on the face, it can be hard to keep focus on the emergency fund.

Emergency funds often come off feeling like something we’re supposed to do, but it doesn’t feel like we’re really getting ahead when we do it. Opportunities, on the other hand, are something that we often passionately want to jump on board with because of the marketing and prevalence of information.

My suggestion for Tim is simple. Set up an automatic savings plan that contributes a reasonable amount to your emergency fund each week, something you’ll estimate yourself depending on your income and your budget. Once that’s in place, forget about it. Let it grow quietly like a mushroom in the cellar and don’t even think about it until a legitimate emergency comes along.

If you want to take advantage of opportunities that come along, use the remainder of your income for those – and go for it.

Eventually, you may find that you have a large surplus in your emergency fund due to years of (luckily) steady life. If you find yourself there, don’t hesitate to take some of that money and use it for another investment opportunity.

Aside from that, though, just set up the automatic savings, sit back, and don’t think about it. Don’t even consider the money you’re putting away to be on the table for any other spending. Pay yourself first.