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Despite the Fed’s latest interest rate hike, your emergency fund isn’t earning enough interest to compete with inflation. The highest interest rate on a standard savings account is hovering around 2%, while inflation is more than four times as big.
With the thought of losing money, it’s understandable why some people are thinking about investing their savings. After all, the average stock market return can beat today’s record-breaking inflation.
But despite these promises, investing your emergency fund is a bad idea. Here are five reasons why:
1. It Might Not Be Available in an Emergency
By definition, an emergency is a serious and unexpected situation that requires immediate action. If you expect your emergency fund to keep up, it needs to be accessible at a moment’s notice — even if it’s a middle-of-the-night trip to an emergency vet clinic.
Unfortunately, some investments can’t offer this liquidity. Sometimes, you’ll have to lock into a limited investment term that can last anywhere between six months and several decades.
Attempting to withdraw before its maturity date can take a bit of paperwork. But more importantly, you may have to pay a charge or penalty for withdrawing your money early.
2. Credit is There But it’s Expensive
By tying your short-term savings in a long-term investment, you might not have the cash to deal with your emergency. But that doesn’t mean your emergency goes away. You still have to pay your emergency vet bill, regardless of what you have on hand.
Most people without an emergency fund wind up having to borrow money online. A financial institution such as MoneyKey provides installment loans and line of credit loans in emergencies when you fall short of what you need.
But if you didn’t like the idea of paying a penalty for withdrawing your investments early, you might not like this option either. All financial institutions apply interest, fees, and finance charges to your principal.
These extra fees mean you’ll pay more by using credit than if you used savings. It doesn’t matter how much you borrow, who you borrow from, or your credit score.
3. You Might Have to Pay Taxes
Another downside of selling shares to cover an emergency is the potential for taxes. If you sell your assets you’ve had for more than one year, these funds will be taxed at the long-term capital gains tax rate. This is less than what you pay on your typical income taxes.
However, emergencies can happen frequently and unpredictably — there’s a good chance you might have to liquidate shares you’ve had for less than one year. In which case, they’ll be taxed at the short-term capital gains rate and pay more money.
4. The Market Can Be Unpredictable
The market can be as unpredictable as the next emergency. And while you’ll almost always earn more money over the long term, your stocks value can fluctuate greatly in the short term.
Unfortunately, your cat might need urgent vet care right as your stocks take a hit, forcing you to cash out when their value is low.
5. There Could Be a Recession Coming
According to the classic “buy low, sell high” rule, investing in today’s bear market could be the right time to get in on the ground floor. However, 72% of economists expect a recession by next year. If that happens, your investments could lose even more value, and they may take several months or years to recover.
And there you have it — five reasons to keep your emergency fund in a basic savings account.
