Should you invest your emergency fund?
Exactly $219.25. That鈥檚 how much I鈥檝e earned in interest on my emergency fund so far this year, at an online bank paying just shy of 1%.
On the one hand, it鈥檚 more than 200 bucks. On the other, it鈥檚 pennies on the dollar, thanks to an era of low interest rates.
Low interest rates have been dragging on for almost seven years. That鈥檚 long enough to have some people, including me, rethinking the long-held advice that emergency funds shouldn鈥檛 be invested because the goal is liquidity, not returns.
Is that antiquated, in the age of credit cards? Is the risk of no return greater than the risk of the market, and subsequently my account, bottoming out?
There鈥檚 no avoiding risk
Dan Egan, director of behavioral finance and investing at robo-advisor聽, thinks so. The company聽聽to invest their emergency money in a portfolio that has a 30% to 50% allocation to stocks. (聽鈥� Betterment鈥檚聽鈥� disagrees. Communications Director Kate Wauck told me that the company 鈥渄oes not believe an emergency fund belongs in the stock market.鈥�)
鈥淵ou don鈥檛 get a bill for inflation, it doesn鈥檛 call you up at the end of the year, you can鈥檛 log on to your cash savings account and see that the amount went down,鈥� Egan says. 鈥淏ut part of understanding risk and return is knowing that you are always exposed to risk 鈥� and in the case of a cash savings account, your predominant risk is inflation.
鈥淵ou need to be honest with yourself about the fact that your cash savings account is going to be losing value every single year, and you鈥檒l continually need to top it off,鈥� Egan continues. 鈥淓very year, your spending will go up, expenses like utilities will go up, and your savings will not.鈥�
I鈥檓 listening, though with a side of terror. My husband is a freelance writer; he has a steady income but it isn鈥檛 a salaried job. He would also tell you that I am, shall we say, a saver by nature. I love having money in the bank; I get a giddy little thrill, Scrooge McDuck-style, every time I make that transfer.
So the hair on the back of my neck stands up just thinking about how I鈥檇 feel if I lost some of that cash to a market correction.
Ed Gjertsen, a financial planner and the current president of the Financial Planning Association, agrees that there鈥檚 risk to low interest rates, but that doesn鈥檛 change his view that emergency money shouldn鈥檛 be invested.
鈥淲ith interest rates at zero-point-who-cares, it is more costly for people to leave money in safe places. You鈥檙e just not making a relatively good return on that investment,鈥� says Gjertsen. But you need this money accessible in an emergency, and 鈥渂y the sheer nature of that it should be safe,鈥� he adds.
It鈥檚 a personal decision
Everything about an emergency fund is personal. The聽that you should put away three to six months鈥� worth of expenses is just that; it doesn鈥檛 account for how easily you鈥檇 be able to get a new job or how many debt obligations you have.
The other question, of course, is how closely your job is tied to the economy. As Gjertsen points out, 鈥淚f the economy is doing poorly and you lose your job, most likely the stock market is doing poorly as well.鈥� If your emergency fund is invested, he says, 鈥測ou鈥檙e just compounding your issues.鈥�
And then there鈥檚 risk tolerance: Those who panic and raid the account when the market takes a dip will easily cancel out their potential returns.
But it鈥檚 also a financial one
I鈥檓 fortunate to have a few credit cards but no actual credit card debt. I can鈥檛 think of many scenarios in which I鈥檇 actually need quick cash, rather than just quick access to money 鈥� aka a credit card 鈥� which is significantly different. I could easily put an expense on a credit card, then transfer money from a聽聽to pay it off.
This idea has a notable flaw, however: It assumes the money will always be there and won鈥檛 have dried up due to a market crash.
Egan鈥檚 answer to that: Those who invest their emergency money should overfund the account, depositing 30% more than is needed. If I want $15,000 in an emergency fund, I should invest $19,500. This protects against a market crisis draining the account; the market could dip as much as 30% and I鈥檇 still have as much as I need.
But that solution has flaws, too. Most people struggle to build even the minimum cash cushion; tacking 30% to that could push the idea out of reach. And I鈥檇 argue that extra money would be put to better use in a tax-advantaged account, like a Roth IRA, where it could grow tax-free for retirement. Because a Roth IRA allows contributions to be, it can function as an emergency fund middle ground.
There are compromises
When I can鈥檛 make a decision, which is admittedly often, I like to split the difference. In this case, that would mean keeping some money close at hand in a savings account 鈥� one with the best interest rate I can find 鈥� and putting some in an investment account allocated fairly conservatively, as Betterment suggests.
This hedges against a couple of things. First, it helps ensure I鈥檓 getting a decent return on at least some of that cash. And it protects against plain old bad luck: If an emergency happens when the market is down, I can tap the liquid cash first and avoid selling investments at a loss.
The bottom line
No return should come at the expense of your peace of mind. I鈥檓 middle of the road, risk-wise, which means the compromise above will work for me. I also probably have more put away for an emergency than a financial advisor would suggest I need, as my definition of need skews paranoid. I鈥檒l leave the bulk of that money in my savings account, where I know it鈥檚 safe and warm, and invest the bit I鈥檇 consider excess.
But if you can鈥檛 stand the thought of investing even part of your own fund, get the biggest FDIC-insured interest rate you can find and be done with it.
After all, there鈥檚 one thing on which I think Egan and Gjertsen would agree: Just having an emergency fund is a major step toward financial security.
Arielle O鈥橲hea is a staff writer at NerdWallet, a personal finance website. Email:aoshea@nerdwallet.com. Twitter:聽.
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