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Should You Invest Your Emergency Fund?

True story. In January 2019, my now-fiancee and I were stuck in a freezing cold AirBnb in rural Upstate New York. It was supposed to be a relaxing weekend. Oops. (Here’s the full story)

But we were financially prepared. Booyah! It felt great.

How? Because we had a fully-funded emergency fund.

We abandoned the AirBnb and didn’t think twice. We knew we might never get refunded, but we didn’t care. We had enough money in the bank to give us options.

That’s why emergency funds are so important. It’s money you can count on when you need it.

But there’s a growing debate in personal finances circles: should you invest with your emergency fund?!

Emergency Fund Basics

The traditional emergency fund is what I described above. It’s a pile of money that sits in your bank account, available for quick deployment in an emergency.

The financial order of operations discusses emergency funds in two ways:

  1. First, save ~$1000 in cash to cover insurance deductibles.
  2. Later, save 3-6 months’ of spending in case you lose your job.

Furnace dies? Got fired? Car accident? Your emergency fund plays an important role in keeping your life afloat.

The “traditional” emergency fund sits in a savings account. Of course, savings accounts right now earn less than 0.5% per year in interest. Not very exciting.

That’s why a growing alternative choice is to invest that emergency fund money instead.

The Arguments For Investing an Emergency Fund

The most popular arguments for investing an emergency fund are…

Returns – the traditional bank-bound emergency fund has near-zero nominal returns. Those become negative returns when we account for inflation. Investing your emergency fund can yield better returns.

Liquidity – the traditional bank-bound emergency fund is highly liquid. It’s cash. It can quickly be withdrawn and spent. For most of financial history, investments have been far too illiquid to be emergency funds. But investment liquidity has drastically improved in recent years. Most investors can liquidate and withdraw their investments within 48-72 hours.

In other words, an invested emergency fund can outperform a cash emergency fund (higher returns) with similar liquidity.

There’s just one drawback: risk.

Risk and reward is the fundamental relationship in investing. Those who invest their emergency funds are taking on risk. But, in my experience, they’re aware and accepting of that risk. It’s all good. They know their personal math:

“I invest my emergency fund in a total stock index fund. Because even if it dropped by 50%, I’d be ok. I’d still have enough money for emergencies.”

I have some thoughts here. Let’s use real numbers.

Let’s Walk Through Some Numbers…

Brennan has a $30,000 emergency fund. He invests it in $SPY, the S&P 500 ETF.

I’m using Brennan only as an example. He’s my friend and an excellent financial educator. He’s free to do anything he wants with his money. I just happen to disagree with him here 🙂

After doing some mental accounting, Brennan figures,

“Even if my fund gets cut in half – down to $15,000 – we’d still be ok. That’s enough emergency money to keep us financially safe.”

Fair enough. But I have a counter-argument to make.

Everyone has a “number” in their head, and hypothetical Brennan’s number happens to be 50% of $30,000, or $15,000. That’s his “pain point.” If the market dropped 60% or 70% (to $12K, or $9K), he wouldn’t feel great about his emergency fund.

To me, that means:

  • Brennan’s real emergency fund isn’t $30,000. It’s $15,000.
  • Brennan should not put the first $15,000 at any risk. It’s earmarked for emergencies. If it went down, he’d feel stress.
  • Brennan should freely invest the second $15,000. It’s earmarked for a future rainy day. If it goes down, he’d feel no stress.

Money is fungible. It can easily be mixed together. But identifying each dollar’s job is an important part of mental budgeting.

An emergency fund is the money you can’t go without. Everything beyond that? It’s not in the emergency fund.

Goals-based investing explains why.

Goals-Based Investing and Emergency Funds

Goals-based investing simply asks:

  • What are your financial goals?
  • How far in the future are those goals?
  • What’s your risk tolerance?

Want a lake house in 30 years? Great! With a 30-year timeline, you have enough time to take lots of risk.

You want a downpayment for a house in 3 years? Awesome. But 3 years isn’t much time to take risk. Instead, let’s invest in short-duration bonds or a short-duration ETF designed for home savings.

Kids going to college in 12 years? Your timeline is somewhere in between the two examples above. A reasonable mix of stocks and bonds is appropriate.

The future date you need the money determines the appropriate risks to take.

What about an emergency fund? What’s the timeline there? Let me ask that another way:

  • When will your next car crash be?
  • When will you get laid off?
  • When will the termites in your neighbor’s oak tree gnaw through that 40-foot limb? No, your garage will not be ok.

The answer, of course, is “you don’t know!” You don’t know when an emergency will strike. But for all intents and purposes, it could be tomorrow. Hell – it could be today!

The investing timeline of an emergency fund is zero days. Therefore, you should not put that money at any risk.

If you think your emergency fund is different, I’d challenge you. Instead, I bet you just have too much cash in that fund. Just like hypothetical Brennan above.

The amount you’re okay losing isn’t actually emergency fund money. Only the money you’re not willing to lose constitutes your emergency fund. And that money shouldn’t be invested.

S.O.S.

This is one opinion in a sea of personal finance commentary. But I feel pretty good about it.

An emergency fund is the minimum amount of cash you need to sleep well at night.

If you invest your emergency fund, you’re putting that cash (and that sleep) at risk. You’re intentionally stressing yourself out.

And if you say you’re fine with losing that money in an investment, then it isn’t part of your emergency fund to begin with.

Thoughts? Leave a Comment below or come yell at me on Twitter.

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-Jesse

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1 thought on “Should You Invest Your Emergency Fund?”

  1. Just like many things in personal finance having an emergency fund is a personal choice. I can see both sides of having one or not and don’t believe there is one right way to look at it. Like you mentioned your return on holding is cash is not great. Therefore if one is trying to optimize and make their cash work for them investing all your cash and not having an emergency fund could be an option. One could use access to credit, insurance and other safeguards which could allow them to forgo the emergency fund all together. Depending on the person that could be an option or seen as unreasonable. This is another one of the unfair things in finance where the people with higher net worth have more choices and less risk than those just starting out which need to be more worried about risk and hold cash for emergencies. Example if a high net worth doesn’t have a emergency fund and needs to use credit to pay for an emergency they could liquidate something and pay off the credit card debit by the end of the month and be ok. A lower net worth person using credit for emergencies might end up compounding the problem if they have to deal with high interest rates if they can’t pay it off at the end of the month.

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