Many people cite staggeringly low interest rates as a reason to skip an emergency fund. Others cite the threat of continuous inflationary pressure. Regardless, it's still a good idea to keep a solid cash reserve on hand for a number of reasons.
Here, we'll look at four reasons investors need an emergency fund.
1. The market is still risky -- despite its recovery
As of October 2021, the S&P 500 index is up a healthy 16% year-to-date. While it's certainly encouraging to know that we're far off the lows of the 2020 flash-recession, there is no guarantee whatsoever that this performance will continue into the future.
Remember: the market is a risky place, particularly in the short term. You simply can't depend on the stock market to fund unexpected expenses, even if it has gone up substantially in the recent past. Nothing beats an emergency fund when the market tanks and you're in need of cash.
2. Peace of mind is underrated
While your emergency fund won't give you Bitcoin-like returns, and will in all likelihood lose money to inflation over time, it will give you peace of mind. An emergency fund of six to 12 months worth of living expenses is meant to cover necessities in the event of job loss or an unexpected surge in costs. This is another way of saying that emergency funds provide some form of comfort should things go awry in some area of your life.
Wise financial planning involves a fair amount of judgment and prudence. People are often very poor estimators of how they'll feel in the future, but anticipating that you'll be happy to have cash at the ready should the market go south is probably a good prediction. Pay for the peace of mind and always have some liquidity on hand.
3. Not every dollar needs maximum return
One of the main criticisms of emergency funds is that you won't earn much of a financial return. Most high-yield savings accounts -- a common vehicle for holding emergency funds -- pay somewhere between 0.25% and 1% annually, depending on how much you're willing to put away and how long you're willing to keep it stashed.
But emergency funds have nothing to do with earning a maximum return. They have to do with providing balance and safety to an already diversified portfolio, and provide you with options should you find yourself if a cash-needy circumstance.
Further, if you depend on the stock market to fund your emergencies, you'll be hurting your long-term prospects if you sell shares at market lows. Because we don't know what the stock market will do next -- as nobody does -- it's best to plan for the very good possibility that you'll need cash from a stable fund.
4. Portability and flexibility are extremely valuable
As inflation creeps up, valuations stretch, and the world accelerates its technological advancement faster than ever before, portability and flexibility come at a premium. Being able to pivot to a new location, career, or life setup has never been more valuable.
No matter how you use your ready cash, simply having an emergency fund ready provides some valuable options not available to those who opt out. From an investing standpoint, a healthy emergency fund may even allow you to add more to your stock portfolio in the event of an unexpected market downturn.
Emergencies can and do happen
If you've been fortunate to never have had a true emergency -- or if you've never experienced an extended bear market -- it can be difficult to know how you'll feel if both happen at the same time. That's why it's imperative that you keep at least a minimally funded emergency account available for you to access at a moment's notice.
The great news is that once you've built a healthy cash buffer, you'll be in an even better position to invest in the stock market for the long term. You'll also find that long-term investing, when combined with a fully funded emergency fund, is an efficient way to meaningfully grow your net worth over time.