FOOL ON THE HILL
"Save for a rainy day" is common advice, but quite different from the long-term investing we advocate here. It can be good to have a separate emergency fund -- more liquid and readily accessible than your stock portfolio -- to deal with sudden emergencies and to reduce the temptation to tap into your portfolio for small short-term needs.
This is a classic reason for savings: to have money to deal with emergencies. An investment portfolio is not necessarily the best tool to achieve such savings, however. Money in your portfolio is not liquid. If you need to pull $1,000 out of it on a Sunday morning because your car died Saturday night and it has to be fixed to get you to work on Monday, you may be out of luck. Mailing yourself a check could take a week, and even wiring yourself the money takes a day or two and usually only works during normal 9-to-5, Monday-through-Friday business hours.
This varies from brokerage to brokerage, of course, and varies further depending on which options you've selected for your account. Sometimes you can get the ability to write checks against your portfolio, giving you easier access to your money. But stop and think about it: Is easier access to your portfolio, and the ability to spend money out of it, a good thing?
The fundamental question here is: Do you WANT to take money out of your portfolio every time you suddenly find yourself needing a sudden $500 for a household emergency? It happens. If your kid breaks his arm, what's the insurance deductible? If your toilet breaks, how much will a plumber cost? These things, unplanned but not unexpected, happen to everyone. But selling stock to deal with life's little crises can lead to a gradual erosion of our portfolios that, if nothing else, really kills our returns.
One way of dealing with this is cash savings. A simple interest-bearing savings account (or possibly a money market account) with perhaps $1,000 in it could do the trick: That money earns very little compared to what we hope our portfolios will, but its purpose is to protect our portfolios from "life's little moments." It's not just about preventing unexpected commissions or the need to sell stock during a down market day, but keeping us from spending money out of our portfolio for short-term reasons.
Another way to handle this is with credit. At 4:00 a.m. you can either pay by credit card or get a cash advance, and if you pay it off quickly the interest doesn't add up to much. The hard part here is paying it off quickly, and not letting this get us into a worse habit than tapping into our portfolio every time we need cash. What could be worse? Carrying perpetual credit card balances at double-digit interest rates could.
If you don't keep cash savings, or if you run your credit cards up and keep them there, the next emergency has to be paid out of your portfolio because you don't have any other ready cash. Many otherwise-savvy investors fall victim to this, and it's a killer.
I'm not offering an easy solution, just reminding people of the problem and how others deal with it. Keep money aside for a rainy day, keep your credit cards paid off -- that's good for multiple reasons -- and avoid the habit of taking money out of your portfolio.
That's at least as important as making good investment decisions.