Building and Investing Your Emergency Fund Wisely

Key Takeaways

• Consider starting with a modest emergency fund goal of $1,000 as a buffer while managing monthly bills and other obligations, then build those savings to three to six months of living expenses.

• One in five U.S. residents have zero emergency savings, and nearly one in three have such savings but cannot cover three months of expenses.

• If forced to sell stocks to have money for an emergency, it is possible those stocks will be sold at a loss, and such a sale can take several days.

It is essential to have an emergency fund for life’s inevitable unplanned events. It is an important part of financial planning. It is also important to know whether, and where, to invest this money. Here is what you should know about wisely building, and investing, an emergency fund.

The Importance of Having an Emergency Fund

Unless one plans to borrow from a friend or family member, or run up a credit card, for every unplanned event, an emergency fund is necessary. And what if there is a job loss? 

The fact is one in five U.S. residents have zero emergency savings, and nearly one in three have such savings but cannot cover three months of expenses, according to Bankrate.

After all, there are definite benefits to dedicating savings for those unexpected times that occur in everyone’s life. Such a stash can cover:

• Income loss. It is necessary to be able to get through an income dip without going into debt or doing long-term financial damage.
• Unplanned medical expenses. Even if medical coverage is in place, such coverage may not take care of all treatments – ambulance transportation or X-rays, for example. 
• Urgent home repairs. With a house, anything can happen, including a suddenly burst pipe, damaged roof, or broken heating system.
• Vehicle repairs. Be prepared for if – when — the car breaks down, as well as for maintenance to keep the vehicle on the road.
• Urgent pet care. When one’s fur baby is ill, the last thing one wants to think about is whether they can pay for treatment.
• Family emergency. If a family member in another state falls ill or is expected to soon pass, it would be most unfortunate to not be able to travel to see them due to a lack of funds.     

How to Start an Emergency Fund

Consider starting with a modest emergency fund goal of $1,000 as a buffer while managing monthly bills and other obligations. If possible, build those savings to three to six months of living expenses.

So that they can be used right away for unexpected expenses, emergency funds should be easily accessible and also have minimal fees.

Here are some tips for getting started:

• Establish a budget to understand where and how one’s money is spent.
• Fix an emergency fund goal. It is best to work toward a clear objective.
• Establish direct deposit. Doing so eliminates the need to remember to save and to manually deposit checks into savings.
• Increase savings over time. One way to gradually increase savings is to raise the amount contributed to the emergency fund by 1% until the savings goal is reached.
• Put aside unexpected income. Put at least part of any windfall into the emergency fund.
• Use a bank account bonus to kick off savings. Banks often provide cash incentives to new customers for opening a savings or checking account. This cash can be helpful in starting an emergency fund or contributing to an existing one.

Should I Invest My Emergency Fund?

In some quarters, the school is still out on whether emergency funds should be invested. In fact, the long-standing answer has been that they should not be.

There are risks in investing emergency funds, particularly in volatile stock markets. If forced to sell stocks to have money for an emergency, a loss can be incurred, and the sale could also take several days. And while bonds are relatively less volatile, they may take time to sell.

However, there are advantages to investing emergency funds, with some insights recommending balancing accessibility with investment growth potential.

Here are key pros and cons to consider:

Benefits

• Potential for high returns. Investment accounts generally pay more than a savings account.
• Funds may still be easily accessed. This is discussed in more detail in the next section, but there are ways in which funds can be invested that allow easy accessibility.

Drawbacks

• It could take longer to access money. Even for accessible accounts, it could take a few more steps to have cash in hand.
• The investor could lose money. All investments carry some degree of risk, some more than others. Stocks are particularly risky.

Best Investments for an Emergency Fund

There are ways other than through a checking or savings account that can be used for emergency funds, ways that can earn returns.

Liquid assets such as high-yield savings accounts, money market accounts, and certificates of deposit are ways in which emergency fund money can be invested. Liquidity is key to easy accessibility without a withdrawal penalty.

• Money market accounts. A kind of checking account and savings account hybrid, a money market account bears interest – between 3% and 4% — and is considered low risk. Some accounts come with a debit card that provides easy fund access.
• High-yield savings accounts. Frequently available through online banks, this kind of account can provide returns of 3% to 4% as well as easy access through check request, funds transfer, telephone transfer, or wire transfer.
• Certificates of deposit (CDs). CDs are federally insured and offer longer maturities and higher interest rates. In fact, many 12-month CDs carry 5% APYs and many five-year, high-yield CDs are in the 4% range. Note, though, that account holders usually must pay a penalty for cashing out a CD pre-maturity, rendering it harder immediately access cash.
• Roth IRA. Contributions to Roth IRAs, which earn an average annual return of between 7% and 10%, may be withdrawn without penalty. Generally, money can be withdrawn at any time. But withdrawing too early can trigger taxes and a 10% penalty.

Practical Tips

There are practical tips for managing and growing an emergency fund, including employing strategies such as automated savings, making budget adjustments as needed, and periodically reviewing the fund.

Other tips include:

• Establishing multiple smaller goals instead of one big one. Reaching a smaller goal – say, a month’s expenses – can provide the motivation needed to keep going.
• Begin with small, regular contributions. To make sure one’s cash flow is not unduly stressed, set the initial contribution level at a relatively small amount.
• Keep a lid on spending. Once your emergency fund is on auto pilot and growing, do not fall to temptation to increase spending.  
• Do not over-save. Once the target goal is reached, begin depositing into an account where it can earn money on its own.  
• Take advantage of any employer-offered 401(k).

Alternative Investments: Yieldstreet

Alternative assets such as real estate, art, transportation, finance, and marine finance are increasingly popular, as investors seek ways to use capital that are minimally connected to an inherently volatile stock market.

The leading alternative platform Yieldstreet, on which some $4 billion has been invested to date, offers these private-market asset classes and more, with a net annualized return of more than 9%.

Previously, alternative assets had been the exclusive province of the very wealthy. Yieldstreet has worked to democratize such opportunities with the broadest selection of alternative asset classes available. 

When deciding whether to use alternative investments for one’s emergency fund gain a clear picture of how an investment’s underlying assets might produce cash flows and assess situations in which such assets may change in terms of value or vulnerability. Also consider the liquidity of such investments.  

An important factor to consider regarding such assets is diversification. Building a portfolio with varying asset types and expected returns is essential to long-term investing success and mitigates overall risk.

Alternative Investments and Portfolio Diversification

Alternative investments can be a good way to help accomplish this. Traditional portfolio asset allocation envisages a 60% public stock and 40% fixed income allocation. However, a more balanced 60/20/20 or 50/30/20 split, incorporating alternative assets, may make a portfolio less sensitive to public market short-term swings. 

Real estate, private equity, venture capital, digital assets, precious metals and collectibles are among the asset classes deemed “alternative investments.” Broadly speaking, such investments tend to be less connected to public equity, and thus offer potential for diversification. Of course, like traditional investments, it is important to remember that alternatives also entail a degree of risk. 

In some cases, this risk can be greater than that of traditional investments.

This is why these asset classes were traditionally accessible only to an exclusive base of wealthy individuals and institutional investors buying in at very high minimums — often between $500,000 and $1 million.  These people were considered to be more capable of weathering losses of that magnitude, should the investments underperform.

However, Yieldstreet has opened a number of carefully curated alternative investment strategies to all investors. While the risk is still there, the company offers help in capitalizing on areas such as real estate, legal finance, art finance and structured notes — as well as a wide range of other unique alternative investments. 

Moreover, investors can get started with a relatively small amount of capital. Yieldstreet has opportunities across a broad range of asset classes, offering a variety of yields and durations, with minimum investments as low as $10,000.

Learn more about the ways Yieldstreet can help diversify and grow portfolios.

In Summary

Establishing and managing an emergency fund is a critical aspect of financial security and financial wellness. Practical investment options include alternative assets, which can also serve the essential purpose of portfolio diversification.