An emergency fund can come in handy when you’re hit with an unexpected expense or a loss of income. From a broken boiler to being made redundant at work, there are lots of reasons to save for a rainy day. Experts typically recommend setting three to six months worth of expenses aside, but you may want to save more if you’re a parent, carer or self-employed.
There’s just one problem. With inflation on the rise and interest rates lagging behind, keeping all your spare money in cash can seem like a bad idea. After all, the costs of goods and services are on the up, meaning your savings are becoming less valuable over time.
This begs the question: should you invest your emergency fund? If you’re wondering whether to pour your emergency fund into your stocks and shares ISA or download a bunch of investing apps, read this first.
Should I invest my emergency fund?
As tempting as it may be to invest your emergency fund, it’s unlikely to be a good idea.
When you invest your emergency fund, you’re putting your money at risk. You may end up with less than you put in and, in the worst case scenario, you may lose it all.
That’s unlikely to happen if you invest responsibly, but you can never be too careful with your emergency fund.
Let me explain…
Why investing your emergency fund in the stock market is a bad idea
When you invest, the value of your investments can rise and fall over time.
These fluctuations are completely normal and, in the long run, the value of your investments should increase.
Problems arise when you invest for the short term, rather than the long term.
If you invest your emergency fund, there’s a risk you may need to use the money when the markets are down. If you sell your stocks during a down period, you’ll get less money than you put in. A stock you bought for £50, for example, might only be worth £40 during a downturn. In some cases, it can be worth even less!
Another example: Let’s imagine you invest your £6,000 emergency fund via an investing app. If you’re lucky and your investments do well, six months later your ’emergency fund’ could be worth £6,500. Unfortunately, it could equally be worth £4,000 if you investments haven’t done so well. If your investments have done really badly, you may be left with hundreds.
Take Peloton stocks, for example. In December 2020 they were worth $162. At the time of writing this in April 2022, they’re worth just $22. So, if you poured your emergency fund into Peloton stocks towards the end of 2020 and needed to use the money now, you wouldn’t have much to show for it!
An emergency fund can make you a better investor
It can be frustrating to see your emergency fund sitting in your bank account doing nothing when long term gains can be made in the stock market, but having a healthy emergency fund can actually make you a better investor!
When you have a healthy rainy day fund safe and sound in your bank account, you can invest in the stock market knowing you won’t have to sell your stocks to pay for an unexpected repair or that overpriced destination wedding that you can’t say no to.
This means you’ll be able to keep your money invested for longer and benefit from more investment growth over time! Even if it’s not invested, your emergency fund can make you richer!
Your emergency fund can help you avoid financial recklessness
Not only can an emergency fund help you make better investment decisions, it can help you avoid making expensive financial mistakes elsewhere too.
With an emergency savings account to hand, you’ll be less likely to take on expensive credit card debt, buy-now-pay-later deals or payday loans.
If you lose your job, an emergency fund may help you find a new job that you actually like. Without any savings, you might have to take whatever you can get.
An emergency fund is valuable, whether it’s invested in the stock market or not!
Where should I keep my emergency fund?
It might not be what you want to hear but a savings account is one of the best places to keep your emergency fund. If you haven’t already saved 3-6 months of expenses, set up a standing order from your current account to your savings account and build yourself a sold financial cushion over time.
Savings rates are so low that many people choose to keep their savings in a current account instead. Current accounts aren’t particularly generous right now either, but if you don’t already have a savings account at the ready, they can be more convenient.
If you bank with Monzo or Starling, you could use their saving pots feature to set your emergency fund aside and avoid the temptation to dip into it.
Keeping your emergency fund in a current account can be a good idea if you may need fast access to the money, but if you can’t help put spend your savings every time you make an impulse purchase, it may be wise to keep your money somewhere else.
Out of sight, out of mind, n all that.
NS&I Premium Bonds are a type of savings account that enters you into a prize draw rather than giving you interest. The smallest prizes are just £25, but there’s also a jackpot of £1m.
It’s a bit like a raffle except rather than buying raffle tickets, you buy bonds for £1 each. The more bonds you buy, the more chances of winning you have.
Unlike a raffle, you can you get your money back! So if you buy £100 of bonds one month and decide you want to sell them a month later, you can withdraw the money back into your bank account.
There’s no guarantee you’ll win – and most Premium Bond holders win nothing, but this can be a good way to save and a fun alternative to the lottery.
How to beat inflation with savings
If you have a large amount of savings and you don’t need the money in the next 3-5 years, investing some of it in the stock market (index funds can be a safer alternative to individual stocks) may be a smart idea. That way, its value will hopefully grow over time, rather than being eroded by inflation.
But when it comes to your emergency fund, try not to worry whether its value is increasing or not. Your emergency fund’s job isn’t to grow. Its job is to protect you from unexpected expenses and expensive debts.