Investing money in equities is critical if you want to build wealth. That's because the stock market has historically provided the best balance between risk and potential returns, enabling investors to put their money to work for them in a smart way.
But while everyone should invest money throughout their life, that doesn't necessarily mean everyone should be investing right now. In fact, around 30% of Americans really shouldn't be putting much -- if any -- money into the stock market. And there's one simple reason why.
Here's why so many Americans aren't ready to invest
It's because they're lacking an emergency fund. A recent study conducted by the Transamerica Center for Retirement Studies revealed that 31% of women and 28% of men have less than $5,000 saved for emergencies. Most experts recommend having enough liquid savings to cover three to six months of living expenses. The millions of Americans with less than $5,000 saved are falling far short of that.
Unfortunately, investing money before you have emergency savings could put you in a tough spot when surprise expenses come up, as they inevitably will. You might have to choose between going into debt or selling your investments, potentially at a loss, in order to cover your surprise costs. And if you're forced to borrow at a high interest rate, that could affect your ability to save and invest later, because you're committing a portion of your future income to creditors.
Investing without emergency savings is always a high-risk proposition, but with the coronavirus pandemic and the 2020 recession increasing volatility in the market, it's an especially bad time to take this chance. A quick look at the recent performance of the stock market shows the potential problem: The market crashed in March and while it quickly recovered over the next few weeks, if you'd been forced to sell investments during the downturn because you lost your job and needed the money to live on, you might have locked in big losses and missed out on the recovery entirely.
Rather than taking the chance of being forced to sell your investments at an inopportune time in an unsafe market, it's a good idea to put your extra cash toward saving for emergencies before investing it. Of course, the one possible exception to this is if you're getting a 401(k) match from your employer, as by passing up the match you're giving away free money.
If you have an employer match, you may decide to contribute just enough to earn it while putting the rest of your spare money into saving for emergencies -- but you need to consider the very real risks before making your choice. In some cases, it's still a good idea to prioritize emergency savings even if it means giving up the match -- especially if your job is high risk and you have no other money to rely on if something happens. Investing money in a retirement account with no emergency savings can be an especially dangerous strategy under most circumstances, as you could face early withdrawal penalties if you're forced to tap your retirement savings early (although this penalty is suspended this year for hardship withdrawals of up to $100,000 made due to COVID-19).
And for those without an employer match, building up your emergency savings before investing is pretty much always the best course of action. If that's your situation, get serious about saving for emergencies before considering putting cash into the stock market.