Should You Invest Your Emergency Fund?

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In the current environment of microscopic interest rates it’s tempting to consider moving an emergency fund into higher-yielding investments, even if that involves taking a bit of risk. Is that a move you’ve been considering – or even should consider?

Actually, the answer to the question isn’t as clear-cut as it seems at first glance. It really depends on your overall financial situation more than anything else.

The Case FOR Investing Your Emergency Fund

Investing your emergency fund can seem like an exercise in insanity, and sometimes it truly is. But there are compelling reasons why you might consider it.

The safest investments are paying close to nothing. The biggest reason why anyone would even consider investing their emergency fund is that rates on short-term interest-bearing savings is now at a fraction of 1% per year. That’s virtually no return on your money at all. Even though emergency funds are set up specifically for the purpose of being prepared for large, sudden and unexpected expenses, you still want to get some sort of reasonable rate of return on it.

Inflation is chipping away at your emergency fund. The reason you want to get a decent return on your money is because of inflation. To say your savings are safe simply because they are invested in vehicles that have zero risk of principal loss is missing the mark. Even if there’s no chance that your savings will drop in value in dollar terms, inflation eats away at the purchasing power of your money slowly, gradually, but relentlessly. If you are not getting at least enough interest to cover inflation, your emergency fund is actually dropping in value every year.

You have a lot more than three months living expenses. Most financial experts recommend that you have anywhere from a minimum of three months to six months living expenses saved in your emergency fund. If you have more than three months saved, and especially if it’s more than six months, there’s a strong case to be made for investing the excess portion in reasonably conservative mutual funds, such as growth and income funds.

You have so many assets that an emergency fund isn’t entirely necessary. If you have a substantial amount of assets over and above your emergency fund, there’s far less risk involved in investing it. The emergency fund may be your primary source of cash in the event of an emergency, but you have other sources of cash if needed. This will enable you to move at least some of your emergency fund into moderately risky investments.

The Case AGAINST Investing Your Emergency Fund

There are plenty of reasons why you should not invest your emergency fund, and if you have any doubt then this is the direction you should lean in.

Playing with money you can’t afford to lose. If your emergency fund constitutes most or all of your ready cash, that is money that you cannot afford to lose. Higher yield always equals higher risk; you never want to be in a situation where your emergency fund investments fall significantly just before you are hit with an emergency.

Investing it eliminates the main purpose. When you invest your emergency fund you’re essentially reclassifying it to be merely one part of your overall investment portfolio. This will defeat the whole purpose of having an emergency fund. The fund is supposed to exist for the sole purpose of being ready to provide cash in the event of an emergency. By investing the funds, you’re actually giving it a dual purpose – investing and emergencies. The problem is that those two purposes do not complement each other.

You have difficulty saving money. In discussing reasons for investing your emergency fund, one of the reasons given was that you have other assets available that you can quickly liquidate in an emergency. But if you have difficulty saving money, or if your emergency fund represents most of your liquid assets, you cannot afford to take on the risk of investing those funds with the potential risk of loss.

You work in an unstable industry or job situation. If you work in a troubled industry or in a traditionally unstable career, you probably will not be in a position to invest your emergency fund. An unstable employment situation is one of the primary reasons for having an emergency fund. For example, if you are in sales and your income fluctuates, you’ll have a greater need for emergency funds than someone who is on a regular salary. In fact you’ll probably need a much larger emergency fund – maybe even one that can cover 12 or more months of living expenses. You won’t want to invest any of that money because you may in fact need it.

You’re prone to emergencies. Depending on your circumstances, career, and past history, you may be more prone to emergency situations than the average person. For example, people with children are more likely to experience emergencies than someone who is single. A person who puts 50,000 miles on their car each year is more likely to have emergencies than someone who only drives 10,000 miles. You have to assess your situation, as well as your history of emergency events. If they occur on a fairly regular basis, you don’t need to be risking any of your emergency funds in anything but completely safe investments.

Do you have any of your emergency fund invested, or are you considering doing so in the near future?

Kevin Mercadante

Kevin Mercadante is professional personal finance blogger, and the owner of his own personal finance blog, OutOfYourRut.com. He has backgrounds in both accounting and the mortgage industry. He lives in Atlanta with his wife and two teenage kids.

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10 Comments

  1. Gambling because the 1% most people see is so abysmal becomes more and more tempting in this distressed economic climate in general but you offer great points for both sides. I especially agree with “Playing with money you can’t afford to lose.” This is the real consideration an investor needs to make before jumping the gun and getting rid of their emergency fund for a risky big gain opportunity. This is a strong topic Mr. Mercadante I hope more share their opinions.

    1. Hi Jared–I’d like to hear more from others too. I understand whey anyone would be unhappy with these dismal returns, but taking risks with emergency money causes more than a few complications.

  2. There is a fairly safe type of investment few people talk about: preferred shares. These shares pay fixed dividends, and therefore hardly ever fluctuate, except to account for the accrued dividends themselves. A fair portion of our portfolio is in preferred shares of REITs and these typically pay around 8% per year. Not bad for a fairly safe investment with near perfect liquidity…

    1. Hi William–Those are in the category of moderately risky, and worth a try for someone who has substantial emergency funds and/or other assets to tap.

      I wonder how those investments would react to rising interest rates though. Especially the REITs since real estate is so debt dependent?

  3. This is a hot topic for me. I hate seeing a large amount of dollars making less than 1% when my retirement accounts are going up by 10-15% the past year. That being said, emergency accounts need to be completely liquid. Think of the difference in interest (1% vs. 10%) as an insurance policy in order to have piece of mind when something unexpected happens. Although, I do agree that if you have more than 6 months of living expenses, you should be investing that because there is rarely a need for more than that in an emergency account. Thanks for the article!

    1. Hi Jake–I don’t want to give the impression that it’s OK to invest emergency funds. It’s OK under certain circumstances, but the majority of people shouldn’t be taking a chance especially if they have no other liquid funds.

  4. Hi Kevin – excellent article. Another little known opportunity is for an individual to invest up to $10,000 per year in Treasury Direct (www.treasurydirect.gov) directly into ‘I Savings Bonds’ which have similar characteristics of TIPS. They currently yield 1.76%. The Treasury Direct website describes them as such ‘I Bonds are a low-risk, liquid savings product. While you own them they earn interest and protect you from inflation.’ One of the benefits of I bonds is that taxes are only due when you sell or redeem them so you can hold them for up to 30 years and only pay taxes when you elect. A couple can invest up to $20,000 a year in these bonds and an additional $5,000 if they elect to invest their tax refund. More information is available here: https://www.treasurydirect.gov/indiv/research/indepth/ibonds/res_ibonds_ifaq.htm

    – kevin cimring

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