If you read my Where Do I Put The Extra Dough? post, you would see that the first place I recommend you put your money is into an emergency fund. Now I’m about to tell you why that advice might hinder you in winning with money. Crazy, right? I’m basically killing my credibility on my other post to help you. Maybe. Here’s why the normal emergency fund advice might be no bueno for you:
- Inflation Eats You Up
Inflation essentially means that you can buy more with $1 today than $1 in the future. For example, if you had $30,000 saved up in an emergency fund in 1997, you would need $45,744 in 2017 to have the same purchasing power in your emergency fund. You lose approximately $15,000 of purchasing power in 20 years strictly due to inflation. If your emergency fund is sitting in cash (which is most likely is), then as time goes on you either have to continue to contribute to it each year or your emergency fund won’t last as long as it used to.
What this is essentially saying is, putting your money into a savings type account isn’t as risk-free as you thought it was. You are likely to not have the same purchasing power of your dollars when you need it as when you put it in. This is because most interest rates for savings accounts are below 1% and the inflation rate is above 1%. Instead of having all of your emergency fund in cash, consider investing a portion of it to help hedge your bet against inflation chipping away at your savings.
- You Probably Don’t Need That Much
The recommended amount you need for an emergency fund is 3-6 months’ worth of expenses. Let’s say you are married with one kid and spend $60,000 a year. You will be advised to have $30,000 in your emergency fund. What the h*eck (shoutout @dog_rates) cost $30,000? Only a few things honestly. Some big house repair or you lost your job and need to live for a few months. If you lose your job, most likely you will cut down your expenses until you can find a new one. Emergency funds are mainly used to cover basic expenses for a few months.
That being said, I would recommend only filling this bucket up to around $15,000 in cash and invest the extra $15,000. If you invest the extra $15,000 at 5%, in 20 years that $15,000 would have grown to approximately $40,000. You never touched the money and you made $25,000. By doing this you aren’t being eaten up by inflation and you’re allowing for the power of compounding to work in your favor.
- You Have Debt
If you’ve read any of my first few blog posts (it’s really okay if you haven’t), you know that I think debt sucks. It really does. I’ve had it before and I’ve paid it off (shoutout How We Got Rid Of Student Loans), so I know the difference in the feelings. Debt can really derail you from reaching your financial goals. In the case of having debt, I like to have a small emergency fund to cover random things (new tires, new fridge, etc.) and spend the excess toward the principal of loans. By doing this, you are saving money in interest that you would be paying and you, after paying off the loan, will have more cash to spend/save each month. (If interested, I can send you an excel sheet I have made that details about how much money you would save if you put down an extra payment each month toward the principal of a loan.) Then, after the debt is paid off, I would fill up the rest of my emergency fund.
After all of that, I’m still a proponent of emergency funds. I think that having a little money socked away in cash is important. Just not as much as you might be told. Be prepared for life to knock you down along the way, but not as if a zombie apocalypse is about to happen. How much you need depends on your situation. Married? Stable job? High expenses? Kids? All of these questions play a role in answering how much you need to have for a rainy day. Just be aware of how much you’re socking away and how much is sitting in cash. All that being said, cheers to avoiding big emergencies but being ready in case something does happen!
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