By Joseph Reinke, CFA
Most people think of having an emergency fund to cover emergency expenses. However, an emergency fund should be used to maintain your financial plan.
In this article, we detail how to use an emergency fund for investments. This is a lesson we learned from wealthy people. If you can’t do it now, be sure to prepare for the next economic contraction and build this fund so you can make money without stressing.
To Start: Investing vs. Money Management
Before we discuss the emergency fund for investments, I want to make sure you are in the right mindset. This is all part of money management NOT investing. In the podcast, I touch on the difference between the two. However, you can deeper dive into the difference between investing and money management by checking out this article.
What Do Wealthy People Do?
The big reason wealthy people get more wealth is that they have cash sitting around ready to invest during economic contractions. That means when everything is going down in value on the stock market, they are buying.
Your job is to replicate those actions. Yes, I know. We don’t all have a stash of cash lying around waiting for the market to drop. So how do we replicate these actions?
Understanding What An Emergency Fund Really Is
We often times think of an emergency fund as having enough cash in the bank to cover expenses for a given period of time. For example, adding up your housing costs, food costs, and utilities for a month then mutliplying that by a number. For example, if these costs add up to $2,500 and you multiply it by three then you’d need $7,500 in a bank account to cover three months of living expenses.
The above example would mean you could lose your income and be able to maintain your standard of living for three months. This is what most people define as an emergency fund and is perfect for those that are trying to “keep it simple.”
However, for those of you trying to up your financial plan to the next level then you need to think about the real purpose of an emergency fund.
The real purpose is not to maintain your standard of living, it is to maintain your long-term financial plan. Therefore, covering your expenses in an emergency fund is absolutely correct but you can use it to maintain your investments!
An Emergency Fund To Maintain Your Financial Plan
Let’s dive deeper into the real purpose of an emergency fund, that is to maintain your long-term financial plan. Many of us set up long-term investments. The two most popular are buying a house and retirement account investing like a 401k.
I’m going to use the 401k to show you how this works. Most people in times of economic contractions are not investing in their 401ks…. in fact they are pulling money out of it!
However, your long-term financial plan was to put money into your retirement every two weeks when you get paid. This is a form of Dollar Cost Averaging and studies show this form of investing works. The reason why it works is that you don’t need to try to time the market.
Therefore, if this is part of your long-term plan, then you should still be doing it even if you get laid off like many are experiencing right now during COVID-19.
So how do you do that? Increase your emergency fund. If you are putting $150 every two weeks into your 401k and your employer matches that then you need to have $300 every two weeks in your emergency fund. If you want to be able to maintain one year of investing, then you need to increase your emergency fund by $7,800.
Then if you get laid off you can open an investment account and keep investing $300 every two weeks. YOU DON’T HAVE TO TIME THE MARKET THIS WAY AND YOU CAN MAKE A LOT OF MONEY WITHOUT STRESSING!
The Hard Part
Many of you at this point might be saying to yourself, “That’s easier said than done. If I get laid off I’m going to panic and not want to invest.”
Guess what? You are right. You can have your regular emergency fund and your “Investment” emergency fund ready to go then the day comes….that day when you get laid off. The hardest thing to do is to keep investing at that point because you don’t know when you are going to work again.
However, if you planned for this and don’t follow through then that means one thing. You didn’t have a large enough emergency fund to begin with. Use this as a lesson and next time have a larger emergency fund.
Resources From FitBUX
Below are additional resources for you to use on your financial journey: