Should I Invest My Emergency Fund?

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An emergency fund can provide a critical safety net in the event of an unexpected expense. But according to the Federal Reserve, 37% of Americans don't have enough money to cover a $400 hypothetical expense with cash alone.

If you're working on building your emergency fund, you may wonder if investing the money might be a good way to grow it faster. And if you have a robust savings account, you might be considering investing part of it so it does more than collect dust and a tiny amount of interest.

Before you put your emergency fund into the stock market, though, it's important to understand the risks you may be taking and what other options you may have.

Is It a Good Idea to Invest Your Emergency Fund?

In most cases, it's not a good idea to invest money you might need in the short term. The biggest reason for this is market volatility.

The stock market has a long-term average annual return of around 10%, but in the short term, it can be extremely volatile. That's not a good thing if you don't know when you'll need to use the money in your emergency fund. If your investments are down when you experience an emergency, you'll have less money to cover the expenses.

Liquidity is another issue you may run into if you invest your emergency fund in the market. The liquidity of an asset essentially means how quickly you can convert it to cash. While you can quickly sell most investments, it can take a few days for the broker to settle the transaction and make the cash available to you in your brokerage account. From there, you'll need to transfer the money to your bank account, which can take another few days.

If you need the money now, though, you may end up having to borrow to get by until you have the cash in hand.

Because of the stock market's high risk and lower volatility, it's generally not recommended to invest your emergency fund money, even though the alternatives aren't as lucrative.

How Much Should I Have in My Emergency Fund?

Financial experts recommend having three to six months' worth of basic living expenses in your emergency fund. That way, you'll have enough stashed away for even the most devastating financial hardships, including a short-term disability or job loss.

However, rules of thumb are more like guidelines than actual rules, so it's important to consider your own financial situation and risk tolerance to determine the right figure for you—and that may be more or less than the suggested amount.

Ask yourself how much you'd need to have in your rainy day fund to help you sleep better at night. If you have dependents counting on your income, a home mortgage to keep up on and a high number of monthly expenses, it may take more to rest easy than if you have fewer obligations.

Safer Places to Keep Your Emergency Fund

Because it's hard to know when you might need the cash, safety and liquidity are typically the two top concerns with an emergency fund. Here are some places you can keep your emergency fund without worrying about losing money in the market:

  • High-yield savings account: High-yield savings accounts function the same as traditional savings accounts but typically offer a much higher interest rate. This rate isn't enough to beat inflation, however, which means your money will lose some value over time in terms of buying power. But the safety and liquidity a savings account provides are tough to beat.
  • Money market account: Money market accounts act as a sort of hybrid of a checking and savings account. They typically offer higher interest rates, which are usually on par or slightly better than high-yield savings account rates, but they also give you even easier access to your money via checks, a debit card or ATM withdrawals. But like high-yield savings accounts, the interest rates aren't going to wow you.
  • Certificates of deposit: Called CDs for short, certificates of deposit can offer even higher interest rates than the other two options, but with a catch: You have to lock your money up for a set amount of time, which you'll choose before you open the account. The longer the maturity of the CD, the higher your rate will be. This can be a nice way to earn more money on your cash, but you may face penalties if you withdraw before your account matures.

How to Build Up Your Emergency Fund

Achieving a maxed-out emergency fund can be challenging for many people, and it may be a years-long effort. Here are some ways you can maximize your efforts:

  • Set and stick to a realistic budget. If you don't already have one, take some time to make a budget for your monthly expenses. Categorize your expenses from the past few months to get an idea of where your money is going, and look for ways to cut back so you can divert that cash flow to savings instead.
  • Establish and automate savings. Instead of making it a goal to save whatever is left over at the end of the month, include your monthly savings in your budget. Then set up automatic transfers from your checking account to your savings or money market account to ensure your budgeted savings don't get eaten up by other expenses.
  • Find ways to bring in more income. Earning more money than you already are may not be possible. But if you can, consider taking on extra hours at work, taking on a second job, starting a side hustle or finding small gigs online that allow you to earn extra cash from home. You can then use this money specifically to build up your emergency fund.
  • Use windfalls. If you get a tax refund every year or regular bonuses at work, you may consider stashing at least some of the cash in your emergency fund.

Build Your Credit to Save More

One way to cut back on expenses is to avoid high-interest debt like credit cards, which can eat into your ability to save.

What's more, having a good credit score will help you qualify for lower interest rates on other forms of debt, which can make room for more emergency savings. It can also help you qualify for lower insurance rates.

Check your credit score to get an idea of the health of your credit history, then take steps to improve your credit to maximize your savings.