Should Your Emergency Fund Go in an Investment Account?

Emergencies happen, and that's why every adult needs an emergency fund. Once you have yours fully funded, it's going to be a sizable amount. The most common recommendation on emergency funds is to save enough to cover three to six months of living expenses. If your essential bills cost $4,000 per month, the recommendation would be saving $12,000 to $24,000.

Considering the amount of money involved, you might wonder if an investment account is a good place for your emergency fund. Instead of having that money sitting around in a bank account, you could invest and grow it.

It sounds reasonable, but it's not a good idea. Your emergency fund should never go in an investment account. While it could work out, there's a serious risk involved.

Why you shouldn't invest your emergency fund

Over long periods of time, investing is the best way to grow your money. The stock market, as measured by the S&P 500 index, averages an annual return of about 10% per year.

But that's not a consistent, stable return. You can't count on getting 10% per year like clockwork. Over short periods of time, the stock market can go up and down quite a bit. Your investments will do great some years and poorly in others. If you invest your emergency fund, the risk is that it could decrease in value before you need to use it.

Imagine that you had invested a $10,000 emergency fund at the start of 2022. You put it in an S&P 500 mutual fund. Unfortunately, the S&P 500 declined by 19.4% that year. Your emergency fund would have been worth a little over $8,000 at the start of 2023 -- bad news if you had a costly emergency and needed to start withdrawing from it.

The purpose of an emergency fund is to protect yourself from financial emergencies. By having one, you reduce your risk of being in a tough position and possibly needing to go into debt. If you invest that money, you're putting it at risk, which defeats the purpose of having an emergency fund.

Where should you put your emergency fund?

The best place for an emergency fund is a high-yield savings account. Here's why:

• Your money will be safe and insured. There's no risk of your money losing value, like there is when you invest it. As long as you pick a bank with FDIC insurance, your deposits will also be insured for up to $250,000 per eligible account in the event of a bank failure.
• You'll earn a reasonable interest rate. Rates fluctuate, but they're high right now, especially with high-yield savings accounts. There are plenty of accounts with APYs of 4%, 5%, or more.
• You'll have easy access to your money. If you have an emergency, you can just withdraw money from your savings account. Some savings accounts have withdrawal limits, normally of six withdrawals per month. That's normally more than enough, but if you want to avoid this entirely, there are also savings accounts with no withdrawal limits.

You don't need to worry about fees, either. There are plenty of savings accounts with no fees or even minimum balance requirements. If you're looking for a good option, check out The Ascent's list of the best high-yield savings accounts.

It's great to think about ways to make the most of your money. But keep your emergency savings and your investments separate. Your emergency fund should be in an account where there's no risk it will decrease in value, and where you can access it at any time. Your investment account is for money you know you won't need for at least five to 10 years.