Just 46 percent of Americans have a rainy day fund, according to the Financial Industry Regulatory Authority, which means that 54 percent of Americans may be just one unplanned emergency away from financial insecurity. If you’re an investor, you may not feel like this statistic applies to you. After all, if you needed money in a hurry, you could just sell your stock.
You may be tempted to organize your assets so that they play double duty, meaning that you’re investing the money to save for your future, but that same money is also serving as a backstop for a financial emergency. However, building your rainy-day fund using exclusively this approach has its own risks, including brokerage fees, unexpected market volatility and potential liquidity problems.
Nothing beats a good, old-fashioned emergency savings account, especially if your investments are at risk of being liquidated to cover the cost of a job loss, extended unpaid leave to a care for a sick loved one, or even an unexpectedly large tax bill.
Here are five tips for setting up an emergency fund to protect your assets and long-term financial security.
Track your spending. First things first. If you’re not tracking your monthly spending, you need to start. There are many popular online aggregation programs that can help individuals and families manage a budget and see where their money is going each month. It’s impossible to find areas and ways to save if you don’t have a clear understanding of your finances, which is why an assessment of expenses, and a written budget are steps one and two in this process.
Maximize what you have. Now, consider maximizing what you do have. It’s a good idea to keep emergency savings separate from other accounts, so if there’s a small amount of cash sitting in your checking or savings account, consider moving all or a portion of that money into an interest-bearing account such as a federally insured money market account or certificate of deposit.
If you don’t have the money to build up a stand-alone emergency fund in the near term, and you’ve maxed out your employer match, consider making additional contributions to your employer-sponsored plan in the form of post-tax dollars. The money will be waiting for you when you stop working if you never utilize it for a rainy day. But, your principal can be accessed at any time without early withdrawal penalty fees in case of an emergency. Plus, it’s generally prudent to have the flexibility to draw down both pre-tax and post-tax money in retirement.
If your employer does not offer the ability to contribute post-tax dollars for retirement, a Roth IRA is another option. With a Roth IRA, you can remove your principal at any time without penalty, with taxes and fees on earnings, only.
[Read: How Non-Deductible Savings Pay Off.]
Invest cautiously. If you do decide to invest portions of your emergency fund, consider non-volatile and liquid vehicles. Given the unexpected nature of most emergencies, it’s important for you to have quick access to money that you know will be there for you in your time in need. You want to look for investments that compound in interest and will be readily available if you need to quickly withdraw.
Take it one step at a time. Consider scheduling small investments on a daily, weekly or monthly basis. This will help you build up a sizeable emergency fund with minimal impact on your day-to-day budget. By utilizing online services and apps such as Acorns, which automatically rounds up your purchases and invests the difference, these small amounts will add up before you know it.
Turn spending into saving. As debts like car loans, student loans and credit card balances are paid off, consider redirecting those funds into emergency savings using an automated transfer (available from most banks) from your checking account, into your savings. You may want to time the transfer to happen soon after your paycheck is deposited each period, so you remain accustomed to living on the previously smaller budget.
As Warren Buffett once said, “Do not save what is left after spending. Spend what is left after saving.”
Keep in mind that your personality and other behavioral characteristics come into play with emergency savings, just as they do with your investment strategy.
Some people can’t sleep at night if they don’t have six months’ expenses in the bank, and some are just fine having one month. Some will feel gratified watching a lump sum grow over time with interest, while others will be more motivated if they see that money growing faster with incremental savings each month.
Whatever your goal, start small and build on your success. There’s no downside to growing your savings, and there’s plenty of upside — both financially and emotionally — to having all of your bases covered.
Disclosures: Investment adviser representative and registered representative of, and securities and investment advisory services offered through, Voya Financial Advisors, Inc. (member SIPC). This information is provided by Voya for your education only. Neither Voya nor its representatives offer tax or legal advice. Please consult your tax or legal advisor before making a tax-related investment/ insurance decision.
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