Should I Invest My Emergency Fund? The Choice Between Safety and Growth
Updated · Aug 03, 2022
If you have a decent amount of money saved, you probably don’t want to watch it devalue due to inflation.
But then conflicting expert advice pops up in your head, and you start wondering.
Should I invest my emergency fund?
Is it worth the risk?
We examine both sides of the argument. Then, we present some alternatives that combine growth with safety and liquidity.
But first, let’s answer another question you may be asking yourself.
How much should I have in emergency savings?
How Much Emergency Funds Do I Need?
According to most financial experts, you should have at least three to six months' worth of living expenses in savings.
But the ideal amount can vary depending on your situation.
For example, if you're a single parent with no family nearby, you'll need more than someone who lives alone and receives financial support.
If you're self-employed, you'll also need a bigger fund to compensate for any fluctuations in your employment.
Besides, you can't take advantage of sick days and holidays like other employees. You need to cover those yourself.
How much emergency fund would you need in that case?
Experts recommend 12 months.
But that’s a huge amount of money. So, where to put your emergency fund?
Let’s see the different options.
Why Should I Keep My Emergency Fund in the Bank?
An emergency fund is a vital part of financial security. It provides a cushion of funds to cover unexpected urgent expenses like medical issues or extensive home repairs.
While there are various ways to invest an emergency fund, most people keep it in a savings account at the bank.
The main argument in favor of checking or savings accounts is liquidity. They are safe and easily accessible, meaning you can withdraw money without penalties.
That said, savings accounts typically have withdrawal limits. That’s not necessarily a bad thing. It means you won’t be tempted to use your emergency money for other expenses.
Plus, your funds will earn interest. Although it’s negligibly low, there’s at least some growth.
Whether you have a $200,000 or a $30,000 emergency fund, you want the money to be safe.
Savings accounts are FDIC-insured up to $250,000 per depositor. As such, they are one of the safest places to keep your money.
You won’t have that protection if you invest your emergency fund. Still, for many the higher return make this a lucrative option.
Why Should I Invest My Emergency Fund?
While emergency fund investments can protect you against inflation, there are also great risks involved.
Still, let’s see why people choose this option.
By investing your emergency savings, you can get a higher return than you would from a savings account.
In fact, the interest rates in most savings accounts are so low that they can’t beat inflation. Essentially, your money slowly (or not so slowly) decreases over time.
It’s a great way to make your money work for you.
Protection Against Inflation
Building a big emergency fund is challenging enough on its own. Watching it slowly decrease over time can be painful.
So, the biggest advantage of investing your emergency fund is that your money won't lose its value due to inflation.
That said, investments come with a risk. The market fluctuates, and there’s no guarantee what your gains will be.
And while technically, you can withdraw your money from a brokerage account at any time, you may incur a huge loss.
You'll need to consider not only the fluctuating market but also brokerage fees and taxes on your gains.
Luckily, some options combine gains with safety and liquidity.
Safe Emergency Fund Investment Possibilities
One of the biggest downsides of investing your emergency fund is that you can’t necessarily access your money quickly.
If the market is down, you may have to wait for it to recover or sell at a loss. This could leave you in a difficult financial situation when you most need money.
To help you avoid that, we present a few alternatives.
For starters, you can leave part of your funds in the bank. That way, you’ll have easy access to them in case of an emergency.
This raises another question.
How much should I invest in stocks?
A good rule of thumb is to invest only what you can afford to lose.
Still, if you want to invest your entire emergency fund, set aside 30% more than you need. That way, even if you have to sell at a loss, you’ll be able to cover your expenses.
In addition, there are other alternatives to savings accounts that are safer than the stock market.
Let’s see a few examples of where to keep your emergency fund.
Certificates of Deposit (CD)
A certificate of deposit (CD) is probably the safest way to invest money.
It offers higher interest rates than savings accounts for the same level of security, as they are FDIC insured. The only condition is that you can’t withdraw it for an agreed-upon term.
Money Market Accounts
Money market accounts are very similar to CDs.
The main difference is that the former pay slightly lower interest. On the flip side, they offer better liquidity.
A Roth IRA is a type of retirement account you can fund with after-tax dollars.
Contributions are not tax-deductible. That said, you can withdraw your funds and any earnings tax-free after age 59½ and a five-year holding period.
It is a good idea to invest your emergency fund in a Roth IRA because of the growth potential and liquidity.
Again, you should deposit only the amount you can afford to hold on to until after you retire.
Health Savings Account (HSA)
If you have a High Deductible Health Insurance Plan (HDHP), you can open an HSA and invest part of your emergency funds there.
You can use the funds to pay for qualifying medical expenses tax-free.
Since you make contributions pre-tax and withdraw the money at any time, many people use them as a supplementary retirement savings option.
While we wouldn't recommend relying solely on HSAs, you can use them as a backup for certain medical expenses.
Whichever option you choose, our advice is the following:
Don't put your entire emergency fund amount in an investment account. Leave some of it in the bank for expenses you can't postpone until the waiting period expires.
Better yet, you can distribute your savings between a few of these options.
That way, you’ll have an emergency fund for quick access in the bank, health issues in an HSA, retirement in Roth IRA, and maybe one you can invest and leave to grow.
As always, the principle of diversification works best.
Naturally, the downside of such an approach is the complexity a larger portfolio brings.
Should I invest my emergency fund?
It can be a good way to earn a higher return and protect your money from inflation. That said, the stock market is too risky for your emergency fund.
A few safer alternatives include CDs, money market accounts, Roth IRAs, and HSAs.
So, weigh the pros and cons and choose a few options that work for your needs.
With an eye for research, Aleksandra is determined to always get to the bottom of things. If there’s a glitch in the system, she’ll find it and make sure you know about it.