Investing your emergency fund 1

That’s right, I invest my emergency fund. I’ve pointed out that, if credit cards are paid off monthly, they serve just fine for an emergency as long as you can free the money to pay those cards again at the end of the month (by selling stock for example).

I’m getting a bit of push back on the investment end of things. The main arguments I’m told it is bad are:
• An emergency fund should be liquid (hold value).
• Emergency fund should be readily available (accessibility).
• If you invest your emergency fund, chances are the market will be down and you lose even more (risk).

Liquid and readily available are not necessarily the same. When you google it many will define liquid as quickly available but  to be liquid actually means to be able to convert to cash without loss of principal, meaning if you stashed away one thousand dollars in whatever vehicle you should be able to convert it back to near or at least one thousand dollars again.

If we go by Investopedia, the term Liquid Assets almost makes it too easy for me to make my case for investing my emergency fund. It defines liquid assets as something that also includes most stocks.

One could argue that a stock market could be in a down turn and you might not be able to convert your stock to the same amount of cash you paid for it. Disaster never strikes alone, right? Surely, when you need that heart transplant the market will be in bear territory (murphy’s law dictates so).

Here is where I feel I need to call BS. Yes, if I invested my $30,000 emergency fund in the stock market tomorrow and the market would drops 10% the week after and in the same week I need to access my emergency fund, I would lose out.

Not only would I lose whatever I need to spend on my emergency, due to the down market I would have also lost value due to the lower stock price.

That’s not how it works though. First of all nobody establishes a $30,000 emergency fund overnight. For many, building such a fund might take many years by adding a couple hundred every month. Secondly, emergency funds often sit unused for years on end. We’ve just had our first emergency in over 18 years.

Hypothetical $30,000 emergency fund

if you listen to Suze Orman you should have 8  to 12 months of expenses in your fund. If you listen to Dave Ramsey he’ll tell you 3-6 months. So in reality it all boils down to how much you spend. You pick what fits for you. For now I’ll use $30,000.

With that number in mind lets walk through a couple of hypothetical scenarios. For the sake of these scenarios I will assume we’re really good at saving and can apply $500 a month to an emergency fund. With that kind of diligent saving it will take 5 years to establish our fully funded emergency fund (That’s right 5 years. How many of you can spare $500 a month?). I will also assume an emergency won’t strike while we are building this emergency fund. If it does you may actually never make it to a fully funded emergency fund.

Checking

Let’s look at the plain vanilla emergency fund that is kept in our Checking account that returns an interest of 0.04%.

After 5 years of payments my checking account will have $30,030.52. No matter how the wind blows, what Wall street or the government does, that amount will not be less than $30,030.52. but…let’s not forget about inflation. That $30,000 planned emergency fund is worth less (in value) due to inflation. If we take a modest inflation of 2% that same emergency fund is really worth “only” $28,552.39.

So much for not losing its value. Anyways, the $30,000 is there and as long as there is an emergency soon you should be good to go. If you’re “lucky” and emergency won’t strike for the next 10 years after you established your fund, inflation will have taken its value down to some $23,000.

You get why I’m wary of keeping an emergency fund in cash? After a blissful 10 years of no emergency my fund will have lost $7,000 in value due to inflation.

investing

Let’s look at the same emergency fund invested in something like SPY. Average returns on SPY over time are widely debated but for the sake of this scenario let’s put it at 8% (very conservative according to many numbers).

Instead of putting my $500 in the bank every month I will invest it in the SPY (at a fee of $9.99)

After 5 years of monthly investments in SPY I will have $36,259.31. Unlike checking this amount can change any day. The Nay Sayers will always say the market could be down when emergency strikes but in general the market actually is up.

I can’t ignore inflation again so I will point out again that with an inflation of 2% that money will really be worth “only” $34,890.60.

Let’s continue in the same vain as the checking account and assume that after having established the emergency fund, emergency doesn’t strike for 10 years. After 10 years that emergency fund will now have $80,482.62 in it. Adjusted for inflation that would be worth $62,537.08.

Let me reiterate:

• Emergency fund in checking after 10 years of emergency-free living: $30,151.89
• Emergency fund in investment (SPY) after the same 10 years: $80,482.62

Emergency strikes

Let’s take the argument of the detractors that will tell you the emergency will happen when the market is down.

Let’s assume 2 years after I established my emergency fund I accidentally set my car on fire. I dropped a cigarette and the insurance company politely declines to pay out. I need to buy a car (used) and I need to dip into my emergency fund for $15,000. To make things worse the market just went into a correction and is down 10%.

Emergency timeline: 2 years after fully funding emergency fund
Amount needed: $15,000
Market down: 10%

Cash with emergency at 2 years

Let’s first take look at the emergency fund in the checking account. The math is pretty simple.

2 years after having established the fund there will be $30,054.55. The fund will cover the emergency and after having bought the new car there is still $15,054.55.
At this point we were able to cover ourselfs but… We now need to rebuild ourfund back up to $30,000. If we can again find $500 a month to put towards our fund it will take about 2.5 years to be back to a fully funded emergency fund.

Investment with emergency at 2 years with 10% market drop

Now let’s look at the invested emergency fund. This time around the 10% market drop makes a big difference.

2 years into the plan with normal returns there would have been $42,528.10 in the stock account but because the market dropped 10% the night before I burned my car (go figure) there now only is $38,275.25.

Wait a minute the market is in a correction and there is still more in my broker account than there would be in my checking account? Something must be wrong??? Well there isn’t, 2 years into the plan at with a 10% correction I would still be better off with investments than having a checking account fund.

The detractors ignore the fact there it took time to build the emergency fund and returns of 8% a year have already been applied to the account.

I’ll do you one better, even if there was a 20% market correction (what we call a bear market) there would still be over $34,000 in the broker account.

On another side note: If the emergency had happened 5 years after you established your fund you would still be fully funded over $30,000 even in a 10% down market after you paid for your emergency but I digress.

The 10%-down-market broker account covers the $15,000 emergency and after having bought the car there is $23,265.25 left in the emergency fund. If you can again find $500 every month to apply to the fund it would take you 1.1 year you refund your fund assuming the market stays flat. Given that a down market tends to recover in 3-4 months it would actually take a lot less than that.

Real life example

Of course what we’ve covered here is all hypothetical and the skeptics will call it just that. It just so happens we recently went through a fairly costly emergency ourselves. For those of you who follow my blog you know, our son broke his elbow about 2 month ago and required surgery to get it all put back together again. To my surprise my deductible ended up being $12,700. I’d say that constitutes as an emergency.

In order to pay for this emergency I had to sell 65 shares of SPY at $198. We weren’t in the 10% correction but at $198 the SPY was down 7.3% from the market high of $213.78.

So we’re talking about an emergency for which I had to sell stock in a down market. I’ll work out the numbers exactly for you (The IRS is going to love this). Selling 65 shares of SPY got me $12,870 which is enough to cover my deductible.

Based in the accounting method of first in/first out the cost basis for these 65 shares was actually $9,161.89. So to make this clear, some time ago I spent a little over $9,000 to purchase 65 shares of SPY and today that investment paid for $12,700 of our medical bills.

Money wise, it seems investing turns out better than keeping it in the bank.

As for the argument of having funds available quickly, I’d like to argue that I can get to funds from my broker account about as fast as I could from my bank. Heck some broker accounts actually come with a check book.

At this point I think I’ll leave it at this. I like to think I’ve made a convincing point why you should not dismiss investing your emergency fund in stock. I’d like to argue you’re actually much better off doing so.

Conclusion:

Checking account (after 5 years of funding): $30,030.52
no emergency for 10 years after fully funding emergency fund: new amount $30,150.88
emergency after fully funding emergency fund: 2 years
emergency cost: $15,000
Market downturn: not relevant
Money left after emergency: $15,054.55
tasks: 2.5 years of monthly $500 deposits to re-establish $30,000 fund

Investment account (after 5 years of funding): $36,259.31
no emergency for 10 years after fully funding emergency fund: new amount $80,482.62
emergency: 2 years after fully funding emergency fund
Market downturn 10%
emergency cost: $15,000
Money left after emergency: $23,265.25
tasks: less than 1 year of monthly $500 to re-establish $30,000 fund

Should I have convinced you to start looking at investing your emergency fund I have to point out: I am not a financial adviser. If you invest your money you should consult with a certified financial adviser.

Investing does come with risk and is not for anyone. Past market behavior is not an indicator for the future of the market.

All right, let me have it. Tell me why I shouldn’t invest my emergency fund.

In the meantime: good luck reaching your financial goals.