Here's why investing your emergency fund is a bad idea

This post was originally published on this site

Select’s editorial team works independently to review financial products and write articles we think our readers will find useful. We may receive a commission when you click on links for products from our affiliate partners.

Editor’s Note: APYs listed in this article are up-to-date as of the time of publication. They may fluctuate (up or down) as the Fed rate changes. Select will update as changes are made public.

Emergency savings can really come in handy when some of life’s disruptions rear their heads. This could be a leaky roof, an unexpected medical bill, job loss or even emergency surgery for a beloved pet. Experts typically recommend having three to six months’ worth of savings for a fully funded emergency account. So unless you just have a spare $10,000 lying around, it can take some time to build up a substantial emergency fund.

But with inflation de-valuing your money over time, it can be easy to feel as if you’re “wasting” the growth potential of your emergency money by only keeping it in a savings account. But before you start researching investing apps, know that there are a few reasons why you should rethink investing your emergency fund.

You could potentially lose the money you invest

Generally, it’s not a good idea to invest your emergency fund. Unexpected expenses, of course, are totally unpredictable and when you invest your emergency fund, you run the risk of possibly losing your initial investment if the value of your assets falls below what you purchased them for. Putting the money in a savings account, however, would preserve your initial deposit for when you really need it.

So let’s say you deposit $5,000 into a savings account; you’ll still have $5,000 in the account a few months later. And if you put the $5,000 into a brokerage account and invest into stocks or index funds, sure, it could be worth $6,000 in a few months if the value of your investments increases. But it could also be worth $4,000, or even less, if your investments lose value. This means you could wind up having less money to cover a hefty surprise expense.

“We have to prohibit ourselves from playing the opportunity cost game with our emergency funds,” said Brian O’Leary, a Wealth Advisor and Senior Analyst at ALINE Wealth. “Don’t say, ‘well had I invested the money, I’d be up X percent.'”

Ultimately, you should aim to preserve the money in your emergency fund. This way, you won’t have to worry about what’s happening with your emergency money during a stressful market environment. Imagine the market tanking, you loosing your job because of the subsequent bad economy and then realizing that you’re emergency fund is worth half of what it was before the market crash.

“By the time a crash arrives, it’s too late to put your seatbelt on,” O’Leary said. “So if you’re not wearing your seatbelt, you need other measures to keep yourself secure. In other words, if your investment goes down you need other ways to get capital. This could mean taking on debt to cover your expenses, and that can end up being really costly.”

You’ll owe taxes when you need to make a withdrawal

Keep in mind that when you invest money into a taxable brokerage account, you’ll be responsible for paying taxes when you sell some shares and realize your gains. The tax rate you’ll pay will depend on when you bought the shares and when you sold the shares.

Profits made from selling assets you’ve held onto for one year or less are subject to a short-term capital gains tax, which will usually be the same as your regular income tax rate. On the other hand, if you sell assets you’ve kept for over one year, you’ll pay a long-term capital gains tax, the rate for which is between 0% and 20%. Generally, it’s better to be taxed at the long-term capital gains rate since you’d typically owe less in taxes. But again, emergencies cannot be predicted, so having to sell your assets less than a year after buying them means you will owe more in taxes.

Instead of investing your emergency fund, consider contributing money to a high-yield savings account. High-yield savings accounts pay you interest each month just for keeping your money in the account. This lets you grow your balance just a little quicker even if you aren’t making regular contributions. Marcus by Goldman Sachs High Yield Online Savings and Ally Online Savings both offer 0.5% APY. The APY generally depends on the interest rates set by the Federal Reserve, so it can change and even increase over time.

Interest rates offered by most high-yield savings accounts have held steady at 0.5% for the last 18 months due to the Federal Reserve lowering interest rates in response to the Covid-19 pandemic. While the rate isn’t very high, it’s better than nothing, and you know that the value of your money won’t fluctuate.

Marcus by Goldman Sachs High Yield Online Savings

Information about the Marcus by Goldman Sachs High Yield Online Savings has been collected independently by CNBC and has not been reviewed or provided by the bank prior to publication. Goldman Sachs Bank USA is a Member FDIC.

  • Annual Percentage Yield (APY)

  • Minimum balance

    None to open; $1 to earn interest

  • Monthly fee

  • Maximum transactions

    Up to 6 free withdrawals or transfers per statement cycle *The 6/statement cycle withdrawal limit is waived during the coronavirus outbreak under Regulation D

  • Excessive transactions fee

  • Overdraft fees

  • Offer checking account?

  • Offer ATM card?

Terms apply.

Ally Bank Online Savings Account

  • Annual Percentage Yield (APY)

  • Minimum balance

  • Monthly fee

    No monthly maintenance fee

  • Maximum transactions

    Up to 6 free withdrawals or transfers per statement cycle *The 6/statement cycle withdrawal limit is waived during the coronavirus outbreak under Regulation D

  • Excessive transactions fee

    $10 per transaction

  • Overdraft fees

  • Offer checking account?

  • Offer ATM card?

    Yes, if have an Ally checking account

Terms apply.

Bottom line

While it may be tempting to invest your emergency fund to potentially grow your balance even quicker, it could be disastrous if your assets lose value by the time you need to make a withdrawal. And of course, there will be a tax consequence when selling assets and withdrawing from a taxable investment account.

But if you still don’t want to miss out on the opportunity to grow your emergency fund a little faster, putting the money into a high-yield savings account is a safer option. It’ll allow you to preserve your total balance regardless of market volatility, and you’ll earn interest just for keeping your money in the account.

Editorial Note: Opinions, analyses, reviews or recommendations expressed in this article are those of the Select editorial staff’s alone, and have not been reviewed, approved or otherwise endorsed by any third party.