Should You Invest Your Emergency Fund?

In the current environment of microscopic interest rates it’s tempting to consider moving an emergency fund into higher-yielding investments, even if that involves taking a bit of risk. Is that a move you’ve been considering – or even should consider?

Actually, the answer to the question isn’t as clear-cut as it seems at first glance. It really depends on your overall financial situation more than anything else.

The Case FOR Investing Your Emergency Fund

Investing your emergency fund can seem like an exercise in insanity, and sometimes it truly is. But there are compelling reasons why you might consider it.

The safest investments are paying close to nothing. The biggest reason why anyone would even consider investing their emergency fund is that rates on short-term interest-bearing savings is now at a fraction of 1% per year. That’s virtually no return on your money at all. Even though emergency funds are set up specifically for the purpose of being prepared for large, sudden and unexpected expenses, you still want to get some sort of reasonable rate of return on it.

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Inflation is chipping away at your emergency fund. The reason you want to get a decent return on your money is because of inflation. To say your savings are safe simply because they are invested in vehicles that have zero risk of principal loss is missing the mark. Even if there’s no chance that your savings will drop in value in dollar terms, inflation eats away at the purchasing power of your money slowly, gradually, but relentlessly. If you are not getting at least enough interest to cover inflation, your emergency fund is actually dropping in value every year.

You have a lot more than three months living expenses. Most financial experts recommend that you have anywhere from a minimum of three months to six months living expenses saved in your emergency fund. If you have more than three months saved, and especially if it’s more than six months, there’s a strong case to be made for investing the excess portion in reasonably conservative mutual funds, such as growth and income funds.

You have so many assets that an emergency fund isn’t entirely necessary. If you have a substantial amount of assets over and above your emergency fund, there’s far less risk involved in investing it. The emergency fund may be your primary source of cash in the event of an emergency, but you have other sources of cash if needed. This will enable you to move at least some of your emergency fund into moderately risky investments.

The Case AGAINST Investing Your Emergency Fund

There are plenty of reasons why you should not invest your emergency fund, and if you have any doubt then this is the direction you should lean in.

Playing with money you can’t afford to lose. If your emergency fund constitutes most or all of your ready cash, that is money that you cannot afford to lose. Higher yield always equals higher risk; you never want to be in a situation where your emergency fund investments fall significantly just before you are hit with an emergency.

Investing it eliminates the main purpose. When you invest your emergency fund you’re essentially reclassifying it to be merely one part of your overall investment portfolio. This will defeat the whole purpose of having an emergency fund. The fund is supposed to exist for the sole purpose of being ready to provide cash in the event of an emergency. By investing the funds, you’re actually giving it a dual purpose – investing and emergencies. The problem is that those two purposes do not complement each other.

You have difficulty saving money. In discussing reasons for investing your emergency fund, one of the reasons given was that you have other assets available that you can quickly liquidate in an emergency. But if you have difficulty saving money, or if your emergency fund represents most of your liquid assets, you cannot afford to take on the risk of investing those funds with the potential risk of loss.

You work in an unstable industry or job situation. If you work in a troubled industry or in a traditionally unstable career, you probably will not be in a position to invest your emergency fund. An unstable employment situation is one of the primary reasons for having an emergency fund. For example, if you are in sales and your income fluctuates, you’ll have a greater need for emergency funds than someone who is on a regular salary. In fact you’ll probably need a much larger emergency fund – maybe even one that can cover 12 or more months of living expenses. You won’t want to invest any of that money because you may in fact need it.

You’re prone to emergencies. Depending on your circumstances, career, and past history, you may be more prone to emergency situations than the average person. For example, people with children are more likely to experience emergencies than someone who is single. A person who puts 50,000 miles on their car each year is more likely to have emergencies than someone who only drives 10,000 miles. You have to assess your situation, as well as your history of emergency events. If they occur on a fairly regular basis, you don’t need to be risking any of your emergency funds in anything but completely safe investments.

Do you have any of your emergency fund invested, or are you considering doing so in the near future?