As part of my journey to retire early, I realized I needed to plan my finances better. That included deciding which to focus on first: build an emergency fund or invest in the stock market. Both have their pros and cons. Let’s take a look at what I considered.
Deciding to build an emergency fund or invest will vary from person to person. I think you also need to look at your long term goals and what you want to achieve by when. Honestly, when I was done looking at the options, I was surprised at my decision. I changed direction.
One quick note, I’m not a financial professional. Always do your own research and consider your own circumstances before making any decisions. I’m sharing what’s working for me and what I’m considering as I build my plans.
How much should be in an emergency fund before investing
The common recommendation is that you should have 3 to 6 months of expenses saved in your emergency fund. You never know when life will take a turn (maybe the loss of a job or an illness) and you find yourself needing to dip into your savings to pay the bills.
The actual amount will vary from person to person. Calculate your monthly expenses and then multiply by 3 or 6 to determine your emergency fund goal.
For example, to cover everything from housing to car payments to utilities and food, you may need $3,000 per month. Your emergency fund goal would be $9,000 for 3 months of expenses and $18,000 to cover 6 months of expenses.
The number may seem overwhelming at first. I know it did for me. While I had an emergency fund started, I put off building it to the full amount. Depending on your future plans (maybe retire from Corporate America early), then getting serious about building this fund faster will be important.
Where should you keep your emergency fund?
Your emergency fund should be kept in a bank account that earns interest, such as a money market account or a high-yield savings account.
Shop around to find the best interest rate available. And also remember to check if there’s an account minimum requirement. No one wants to be charged fees or miss out on extra interest earnings! Usually your local bank will have a lower interest rate on savings accounts compared to online high yield savings accounts.
Money market accounts and high yield savings accounts usually have a limited number of monthly withdrawals. That’s ok since this account is meant to be used only for emergencies, not paying your regular bills. I have a credit card available to cover any immediate bills and then pay the bill in full when it comes due from a savings account or sinking fund.
Finally since the Great Recession, the interest rates on the high-yield savings accounts are back on the rise. I miss the days of 4 1/2%+ interest rates. Those accounts really helped me save the downpayment for my first house. Today you can find rates that are more than 2% which is great improvement over the last few years. Check out Capital One, Ally, and Marcus by Goldman Sacks for example.
Should your emergency fund be invested?
I follow the 5 year guideline when it comes to deciding between keeping cash in the bank versus investing in the stock market.
The theory is that you may need at least 5 years to recover any losses if the stock market goes into difficult times. It’s a hard choice because in good years you’ll see a better increase in the value of the account compared to a high-yield savings account. But in the bad years, you’ll be thrilled that your money is safe.
Ultimately it becomes a personal decision and one you need to make based on your situation. Ideally though you should at have at least some money in cash (you decide how much) as you don’t want to run up high-interest credit card bills or need to sell stock to pay the bills.
How I decided between investing and fully funding an emergency fund
I spent a Saturday morning looking at the money I had available, goal timeframes, and my income. What I realized was that I needed to focus on building out 6 months of an emergency fund first. Pausing on additional investments would allow me to fully fund the account by the end of the year.
Additional budget reworking may find additional money to either fund my emergency account faster or begin investing again. For now, I have a plan that works for my situation.
Over to you, did you decide to build your emergency fund or invest?
Ideally if you have the money and time available, trying to build both at the same time is great. You solve both short term and long term goals. For me, I decided to pause on additional investing to prioritize fully funding my emergency fund first.
What went into your decision making process?
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