Why To Have An Emergency Fund?
As an investor you want to have your money working hard for you by bringing home dividends. So it makes sense to have as much money as you can spare in investments that generate income for you. An emergency fund gives you, the investor, peace of mind. Knowing that you can cover unexpected costs without having to dip in to your income-earning investments in the stock market.
In order for your investments to generate maximum income for you, you have to stay invested for long periods of time.
The last thing you want to do, is sell your shares in businesses paying you routinely.
But sometimes things can happen that you don’t see coming. Such as car trouble or home damage from extreme weather. You have to be prepared to cover any costs that come from it without taking on debt. That is where having an emergency fund gives investors some peace of mind. You can fund the short-term expenses from the cash set aside. This leaves the investments doing what they do best – paying you dividends.
It allows you the investor to focus on putting together a portfolio that is going to provide the income needed in retirement. Knowing that there is money put aside that will cover whatever unexpected expense might pop up.
It might be tempting to keep a lot of cash in hand to give you the that peace of mind that you can handle short-term problems.
But the money that is set aside isn’t gonna generate income for you to retire on in the future.
Whilst the size of your emergency fund depends on your own situation. I personally think around 4-5 months of usual expenses kept aside provides enough peace of mind. It also doesn’t keep too much money on the sidelines.
Where To Park The Emergency Fund?
You definitely should not invest the money set aside for emergencies into any investment opportunity. Doesn’t matter how safe or stable it might seem. Markets are volatile in the short-term and you need to protect that emergency money from the movement of the stock or bond prices.
That doesn’t mean you should stuff your emergency fund in the mattress or keep in idle in your bank account.
Keeping the emergency fund in a bank savings account allows to earn a small percentage on that money.
It’s not gonna generate much income, but as you are in charge of your finances you want to squeeze every bit of productivity you can get out of your money.
You should compare the yields on offer for savings accounts in your country and go with the highest government-guaranteed yield on offer that allows you to withdraw funds from it without any fees or penalties.
Summary
The emergency fund is a safety net. It allows you to maximise your passive income through stocks without having to sell them when an unexpected expense comes up. Emergency fund’s main goal is not to generate income for you. It’s not gonna make a lot of money in a savings account after inflation. But it gives investors peace of mind, knowing that they can cover surprising expenses when they come up, whilst leaving their investments to compound.
