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As uncertainty looms this year, a proven emergency fund is more important than ever.
Word on the street suggests tentative confidence in a soft landing, but there are outliers as well. Some cautiously optimistic economists point to the S&P 500’s miraculous recovery as evidence that a bull market is set for 2024.
More pessimistic analysts also believe a hard landing is likely, citing ongoing inflation problems, interest rate cuts and upcoming elections in half of the world’s economies as red flags. (The rematch between Biden and Trump is just one of 40 elections scheduled for 2024).
When it comes to emergency funds, no such conflict exists in the financial world. An emergency fund has been, and always will be, the cornerstone of good financial management.
Above all, it is the biggest need for first-time investors. Unfortunately, very few people have this important financial safety net.
Michelle Henderson – ZVprbBmT8QA – Unsplash
More than half of Americans have no emergency savings
An unexpected $1,000 expense would upset more than half of American adults. That’s according to Bankrate’s latest research, which shows that 56% of Americans don’t have $1,000 in savings.
The majority of these cash-strapped individuals, approximately 35%, must borrow money to cope with expenses of this magnitude.
- 21% of them reach for their credit card, tap into their available credit, and take the time to pay for emergency expenses.
- Another 10% ask for help from a loved one and take out a personal loan from a friends and family bank.
- Only 4% of people plan to use a bank, online direct lender, or credit union to get a personal loan.
Post-pandemic: Less savings, more debt
New data from the US Federal Reserve paints a similar picture on savings. This shows that a whopping 80% of Americans have less cash reserves than they did before the pandemic began. Bank deposits and other liquid assets have plummeted, with low-income earners bearing the brunt.
A growing number of Americans are relying on credit cards and personal loans because they don’t have enough savings. Delinquencies and credit card debt are both above pre-pandemic levels, with more than a third of Americans collecting more credit card debt than they are saving.
According to the Federal Reserve, the average American currently owes $59,580. This high amount of debt makes it difficult to make ends meet, let alone invest in a strong portfolio.
Why you need emergency cash reserves rather than investments
Considering that investing is the single best way to build wealth, it’s understandable that you might invest your cash in stocks and bonds instead of using your emergency fund. A diversified portfolio puts your money to good use and takes advantage of higher rates of return to grow your reserves over time.
However, you may regret investing the cash that was supposed to build your emergency fund. Remember that analysts have little certainty about what the stock price will do next year. Historical evidence shows that stock prices almost always rise over time, but they can experience sharp ups and downs along the way.
Similarly, you cannot predict when an emergency will come into your life. It could happen at the worst possible time for the market.
Due to the nature of the emergency situation, withdrawals cannot be strategically timed to maximize profits. You run the risk of having to cash out long before your investment can reach its full potential. Even worse, if you are forced to withdraw during a recession, the value of your funds could drop significantly.
Prioritizing your emergency fund before your portfolio reduces this risk. A financial advisor ultimately recommends that he set aside three to six months’ worth of living expenses in a fund, but the amount needed depends on your situation. Having even $1,000 in a savings account can help him deal with emergencies without having to take out a personal loan.
Having some cash set aside for emergencies also protects your portfolio once you start investing. By saving for a rainy day, you can tap into this cash before withdrawing from your investment. If you hit the recommended 3-6 month savings goal, you won’t have to unload at all, giving your investments the best chance of growth.
Find out how to make your emergency fund a priority
When you set goals this big, you need to have a good grasp of your budget and identify unnecessary expenses. Turn unnecessary subscriptions, services, and splurges into savings to grow your emergency fund.
Debt also needs to be addressed. Some financial advisors recommend paying off all debt before investing, while others recommend calculating the return on investment against the cost of borrowing.
Paying off high-interest debt is important because expensive credit cards and lines of credit will accrue interest if you don’t pay them off right away. There is no better rate of return than a high annual interest rate. Some high-value loans have interest rates as high as 300% per year, while the average return on the stock market is about 10% per year. If left unaddressed, compound interest can add to your debt, eat into your paycheck, and reduce the amount you have available for investments.
And with prices rising faster than wages, you may have to consider a new job in the face of a cost-of-living crisis. Having more money in your budget makes it easier to balance multiple financial goals, like building your emergency fund and building your portfolio at the same time.
Upgrading your salary may be more difficult than adjusting your budget, but this goal promises to give you more savings than canceling Netflix or Spotify. Take time to look for networking, volunteering, and training opportunities. Taking these steps will get the wheels moving and you’ll know what you need to do to climb the corporate ladder and land a higher-paying job in the future.
What to do after establishing an emergency fund
Once you’ve set aside some cash for emergencies and taken care of high-interest debt, it’s time to think about your investment goals.
Full disclosure: Even if you have an emergency fund, you still face some risks when investing in the market during times like these. You can reduce these risks by making informed decisions about managing your portfolio in volatile markets.
Before making these decisions, you should set boundaries, either on your own or with the help of a professional.
Here’s how:
- Identify short-term and long-term financial goals.
- Know your risk tolerance. All investments involve risk. You have to decide whether you can handle the maximum risk (i.e. losing all your funds) in order to get the maximum profit (higher profit). If this is out of your comfort zone, you can choose a more conservative option.
- Compare your asset allocation and goals. Different assignments can support different goals.
- We strive to diversify. By choosing a diverse group of investments, you may be able to weather economic storms that affect some classes or industries more than others.
- Take advantage of an employer-sponsored retirement plan where your employer matches your contributions.
Key points:
Investing may be the single best way to grow your wealth, but the best way to protect your wealth is to save for an emergency fund. After all, you can tap into these reserves to prepare for emergencies without taking out a personal loan or withdrawing your investments at an inopportune time.
With market uncertainty looming, now is the perfect time to focus on your emergency fund. These savings form the basis of a strong investment plan.
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