October has been a volatile month for the stock market, so much so that many investors are wondering whether we're headed toward a bear market. But despite the rockiness, the stock market is still a great place to put your money. Historically, stocks have delivered much more substantial returns than bonds, and statistically speaking, those who take a long-term approach to stock investing are more likely than not to come out ahead. But while I'm certainly all for investing in stocks, I'm not a fan of using a stock portfolio as an emergency fund. Here's why.
The stock market just isn't stable
We all need emergency savings to cover life's many unknowns. Whether it's your car breaking down, your roof collapsing, or your job getting downsized, you need money on hand to cover expenses that hit you out of the blue. If you don't have savings earmarked for such a purpose, you're likely to run up a huge tab of debt the next time you're faced with an unanticipated bill, and that could hurt your finances for many years to come.
Ideally, your emergency fund should have enough money to cover from three to six months of living expenses. Unless you have special circumstances, however, such as a very unstable job, you're generally safe to stop at the six-month mark and invest the rest of your money in something that will produce a better return than most savings accounts are offering today. But make no mistake about it: That initial three to six months' worth of living expenses belongs in the bank, and no place else.
Now you might be shaking your head thinking: "If I leave that much cash in the bank, I'll earn practically nothing on it." And that's probably true. But consider this: Last week, my stock portfolio lost $10,000 in value in a single day. And though the market had been shaky for most of the month, that sort of drop wasn't something I was anticipating.
It's also not something that's particularly affected me, and here's why: I'm not touching that money. My stock portfolio is part of my long-term investment strategy, so the cash tied up there is money I'm not planning to use anytime soon, especially since I have a healthy emergency fund in the bank.
But imagine what would've happened had I needed an influx of cash on the very day my portfolio value dropped $10,000. In a nutshell, I would've had no choice but to sell off investments and suffer a serious financial loss as a result of nothing more than bad timing.
And that's why your emergency fund really doesn't belong anywhere other than the bank. When you fund a savings account, your principal stash is protected (provided you stick within FDIC limits, which, let's face it, most of us will). This means that if you put $10,000 in the bank, you're guaranteed to have that same $10,000 (plus interest) available to you when you need it. You won't have to worry about market activity or political turmoil or any of the other things that cause stock values to plunge out of nowhere. And you won't bear the risk of taking a serious loss because you needed money at the worst possible time.
The reason to have an emergency fund in the first place is to buy yourself not just financial protection but peace of mind. And if you keep your emergency cash in stocks, the latter will be pretty hard to come by.
The Motley Fool has a disclosure policy.