“Save what you can towards the emergency and life happens fund. Don’t worry yourself sick about the slow growth. The point is it’s growing even if it’s just one dollar at a time ” – Michelle Singletary –
When it comes to wealth building, it’s best to have some money put aside in case of an emergency. That last thing you want to have to do is liquidate one of your investments because you need money immediately. The whole purpose of investing is to build wealth over time. Your savings and your investments are two separate components to your wealth portfolio.
To be clear, your emergency fund is not an investment! It’s insurance you put into place to protect your investments so that you don’t have to liquidate them at the risk of penalties, taxes and fees. It is part of your wealth portfolio as a buffer.
I want you to think of building your investment portfolio like that of building a house. Before you can put up the walls and roof, you first have to lay out the plumbing and utilities network. Then you pour the foundation and after that you begin constructing the frame. So begin the journey to wealth building on the right path.
There’s some mixed philosophies out there about how much you should put into an emergency fund. Ranging anywhere from $1,000.00 up to six months of expenses is the norm. I’m more in the Dave Ramsey camp of $1,000.00 and then paying down debts with what’s left over after typical monthly expenses.
Where I differentiate from what Dave Ramsey believes is that I believe that you should put 10% of your after expenses money towards investing and then pay down debts with the remaining amount. Dave believes you should pay down all of your debts first before investing.
If you’ve ever heard the fable the richest man in babylon then “A part of all I earn is mine to keep” will make sense. And it’s putting that 10% to work so it can earn even more over time that attributes to financial growth.
Now don’t get me wrong, I’m not saying that you shouldn’t pay off your debts as quickly as possible. What I am saying is that I’m in the “pay yourself first” camp. You can still pay down debts quickly while you build your wealth portfolio slowly and save hundreds if not thousands of dollars in interest simultaneously.
Another reason I believe you should invest 10% of after expenses funds while paying down your debts is because of habit building. It’s extremely important to habitually invest every time you earn income. It needs to become so second nature to you that forget you’re doing it. It’s time to inherit the “set it and forget it” mindset. If you can’t afford 10% at the moment then start off with 1-2% if you can. The point is to form the habit and make a commitment to building your wealth portfolio.
The one thing that you definitely want to do with your emergency fund is keep it in a moderate yielding savings account that pays around 2% (200 basis points). This way your savings is earning you a small amount of money while waiting to be called upon. Two percent isn’t much, but most banks are only paying fractions of a percent on savings accounts these days. A 2% return is a lot better than a half a percent or less.
Another potential option is parking it into a Roth IRA. In the investment community it’s taboo to pull money from retirement vehicles like 401K’s and IRA’s. But a Roth IRA is a bit different in the fact that your contributions can be pulled without any tax penalties. The pros to parking your emergency fund into a Roth IRA:
- The contributions can be taken out without tax penalties.
- While the money is in the Roth IRA, the earnings made grow tax free.
- You can put up to $6,000.00 a year into Roth IRA’s.
There is a con to this as well, there’s always the risk of the market crashing and the risk of your contributions being affected as a result. Since market disruptions do occur, that is something to consider.
I believe you should break up your emergency fund into different segments.
- Cash, you can’t go wrong with having some cash on hand.
- Moderate yielding savings account. Let your money earn something while it’s put aside.
- Roth IRA since you can pull from the contributions tax and penalty free.
- Dividend paying life insurance policies. This one is the most controversial because there is a low interest rate on the loan, but the upside is that you can delay paying it back indefinitely since the death benefits would cover the loan plus interest at the time of your death.
Building an emergency fund is being financially responsible by being proactive. Having financial insurance is wise even if you never need to use it. You hope to never get into a car accident, but you have car insurance right?
Don’t be like millions of Americans who right now can’t even come up with $400.00 for an emergency without having to sell something to do so. As a member of the Refresh Financially community, you’re on the path to being financially savvy.
Brad Finn explains what I’m talking about really well. Take a few minutes to check out this video:
As I like to always say… “the journey begins with the first step”.
Be sure to subscribe to the blog if you haven’t done so already because I’ll be putting up more wealth building posts in the near future.
Until next time… be sure to comment below and let’s get some dialogue going.