Fed up (no pun intended) with the low rates you’re earning on your emergency cash reserves? Me too!
And it only gets worse thinking about the fact that the stock market can make more in a day than my cash has earned in six months. But guess what? That doesn’t mean moving your emergency funds into riskier investments is the answer.
A Dangerous Approach
While it’s true that market-based mutual funds potentially offer greater returns, trying to build an emergency fund with them is a slippery slope.
Why? Because although investing in mutual funds provides the potential for greater returns they also come with the potential for greater volatility; and volatility and emergency funds typically don’t mix. In fact, one of the most important traits you should seek in finding a home for your emergency fund is stability.
Why? Because unlike stability, which may seem a little boring at times, volatility works both ways. Not only could the value of your investment increase, it could also decrease, even to a point of being worth less than what you’ve invested.
If you’ve got the time to wait for it to come back up, this might be a nonevent. After all, that’s just the nature of market-based investing. However, if an emergency happens at the same time as one of these downturns, you could find yourself having to sell and take a loss on the very pool of money on which you were trying to earn higher returns. Talk about not getting what you were hoping for!
A Good (or Bad) Example
To illustrate this point, let's look at some relatively recent performance numbers for the S&P 500 index. On Jan. 2, 2008, the opening value for the S&P 500 was 1,447.16. On Dec. 31, 2008, it closed at 903.25. That is a drop of almost 38%. To put that in dollar terms, let's say you had an emergency fund of $30,000 invested in the S&P 500 at the beginning of 2008. Let's further assume that no emergency occurs until the end of December and when it does, you need to pull out $5,000 from your reserves. Would you really want to take this withdrawal when your $30,000 original investment is only worth $18,600? I sure wouldn't!
Emergency Fund Points to Live by
Obviously, this is an extreme example, but I think it illustrates the important points here pretty well:
- We have no idea when an emergency will occur.
- We have not idea when a market-based investment will drop in value.
- We do have a pretty good idea that each will occur at some point.
It is for these reasons that I really believe the conventional financial planning wisdom of keeping your emergency funds in stable, liquid savings vehicles is still sound advice.
In the end, it’s your money and you can do with it what you wish. Personally though, I’d rather complain about low interest rates than lost money.
- Investing in securities products involves risk, including possible loss of principal.
- Past performance is no guarantee of future results.
- The S&P Index is a well-known stock market index that includes common stocks of 500 companies from several industrial sectors representing a significant portion of the market value of all stocks publicly traded in the United States. Most of these stocks are listed on the New York Stock Exchange
- Examples given are hypothetical illustrations and not necessarily an indication of the benefits or features of any USAA product.
- DID 150236-1113
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