You’ve probably also heard that you’re supposed to keep this money in a savings account, safe and sound, so that you can be sure it’s there when you need it.
And while you definitely want this money to be safe, it probably bugs you at least a little bit that your savings account is earning next to nothing. After all, you’ve worked hard to save that money, and it would be nice if it worked for you as well.
So the big question is this: Does it make sense to invest your emergency fund?
The default answer should almost always be no. Your emergency fund’s primary function is to be there when you need it, and investing it inherently exposes you to at least some level of risk. Plus, you can keep it in an online savings account that at least gets you a 1% return, which is certainly better than nothing.
So, especially if you’re in the early stages of building your emergency fund, you should put it in a regular old savings account and stop worrying about it.
But there ARE some strong arguments in favor of investing your emergency fund, and in this post we’ll explore why you might want to consider it.
Reason #1: It’s Still Accessible
At the very least, you need to be able to access your emergency fund quickly if the need arises.
And while you may typically think of investing in the context of retirement accounts and all the associated restrictions, the truth is that there are plenty of ways to invest in a way that keeps your money accessible.
The simplest is to use a regular brokerage account. You can invest just like you would within a retirement account, with the bonus that you can withdraw some or all of your money at any time if an emergency comes up.
You could even keep your emergency fund in a Roth IRA, which allows you to withdraw up to the amount you’ve contributed at any time and for any reason.
The bottom line is that investing doesn’t automatically lock your money away for the long term. There are ways to invest that still allow you to access the money quickly if needed.
Reason #2: Better Returns
While nothing is guaranteed, investing gives you the chance to earn much better returns than you can get from a savings account.
I ran some numbers to see just how big a difference it would make. I assumed that you contributed $200 to your emergency fund each month until you had saved $24,000, enough to cover 6 months’ of expenses at $4,000 per month. Then I assumed that you would earn 1% annually in a savings account and 6% in an investment account. I ignored taxes.
What I found is that after 10 years you’d have $5,628 more from investing. After 20 years it would be $27,481 more. And after 30 years the difference would be $68,438.
Now, there are a lot of assumptions here, and nothing is guaranteed. But clearly investing gives you the chance to end up with a lot more money than keeping it in a savings account.
Reason #3: Better Odds of Success
One of the frequently cited reasons against investing your emergency fund is the risk of a big market crash right when you need the money. And that certainly is a risk.
But recent research suggests that investing your emergency fund actually increases the probability of having enough money on hand to cover an emergency. They have plenty of numbers and charts to back up their conclusions, but the gist of it is that true emergencies are relatively rare and that the higher returns you get from investing your money in the meantime make it more likely that you’ll have enough to cover those emergencies when they happen.
This is probably less applicable for clients who earn less money, and therefore have less wiggle room to make adjustments in the case of smaller unexpected expenses. But at least in terms of planning for bigger emergencies, like job loss or disability, it’s at least possible that investing your emergency fund gives you greater security.
Reason #4: You Have Other Money
Given that big emergencies are relatively rare, you should consider the fact that other accounts you’d prefer not to touch could serve as a backup plan if you ever found yourself in the perfect storm of needing money right in the middle of a market slump that depleted your dedicated emergency fund.
For example, in an ideal world you wouldn’t touch your 401(k) until retirement. But if you did face a big financial emergency, there are hardship provisions and loan provisions that would allow you to access that money if you needed it.
In other words, the downside of investing your emergency fund might not be a complete lack of funds when you need them. It might just be having to access funds you’d rather leave untouched.
And if the upside is better returns and more money, that risk may be worth it.
Reason #5: You Have More Than You Need
Let’s say that you need $24,000 for a six-month emergency fund. And let’s say that you have $50,000 saved up outside of retirement accounts.
A reasonable rule of thumb is to expect that you could lose 50% of the money you have invested in the stock market in any given year. That would be an especially bad year – like, 2008-2009 bad – but it could happen.
Using that rule of thumb, you could put your entire $50,000 into the stock market and still be fairly certain of having six months’ worth of expenses on hand, even during a market crash.
So if you have much more money on hand than you anticipate needing in an emergency, you may be able to invest it without actually risking much of anything.
To Invest or Not to Invest?
With all of that said, there are a lot of good arguments for keeping your emergency fund in a regular savings account. It’s safe, it’s convenient, and you can get at least a reasonable interest rate with an online savings account.
There’s even research showing that having cash on hand is correlated with overall happiness and life satisfaction, and who doesn’t like that!
But if you’re willing to be a little adventurous, and if you can cover smaller irregular expenses like car and home repairs with other funds, you may be able to come out ahead both in the short-term and the long-term by investing your emergency fund.
Matt Becker, CFP® is a fee-only financial planner and the founder of Mom and Dad Money, where he helps new parents take control of their money so they can take care of their families. His free book, The New Family Financial Road Map, guides parents through the all most important financial decisions that come with starting a family.