Welcome to the Fight Fire With FIRE Investing Guide! This is the first in a 16-part series that will cover everything you need to know to get started investing. But before we get into the nuts and bolts of investing, there is some important ground to cover first.
Much is made about how to invest—and indeed, this being a guide to investing, that will be where we focus most of our efforts—but no guide to investing would be complete without a discussion first of when to invest. After all, investing takes place within the framework of a larger financial picture, and I will be among the first to say that not all people stand ready to invest in their current situation. There are a multitude of aspects with any financial plan—savings, debt, insurance options (e.g. health, car, homeowner, disability, life), will preparation, and so on—and we will not be able to cover all of them in the scope of this guide. But I do want to address two especially important considerations for would-be investors.
We’ll cover the first today: your emergency fund. Let’s get into it.
Your Emergency Fund
An adequate emergency fund is the foundation of any solid financial plan. It is what allows you to navigate potentially devastating circumstances—job loss, unexpected medical bills, a new roof—without exposing you to financial ruin. Yet unfortunately, savings takes a back seat for many Americans. A report from the Federal Reserve dated May 2019 noted that, “If faced with an unexpected expense of $400…27 percent [of those surveyed] would borrow or sell something to pay for the expense, and 12 percent would not be able to cover the expense at all.” Consider what this means: an estimated 39% of all Americans exist in such a tight financial space that an unexpected $400 expense would force them to sell something or drive themselves deeper in debt. This is truly walking the razor’s edge—and it has surely not improved with the financial impact of COVID-19. An emergency fund is absolutely critical.
Your emergency fund is what allows you to navigate potentially devastating circumstances—job loss, unexpected medical bills, a new roof—without exposing you to financial ruin.
So, what is an adequate emergency fund? Well, the honest answer is that this will vary from person-to-person, and depends largely on your individual situation. But as a rough rule of thumb, most experts (and I agree with them) recommend holding at least 3-6 months’ worth of living expenses as an emergency fund. It is worth noting that as the name implies, this money is for emergencies only; it is your safety net should things go off track. It should not be used for non-emergent spending, or for planned savings goals (e.g. down payment for a home, car purchase, and so on), which should be considered a separate financial objective in your plan.
The amount needed (3-6 months’ expenses) is fairly simple to calculate: add up all of the things every month that you have to (not want to) spend money on, and multiply this number by 3 to 6 to reach your target emergency fund amount. For example, if you sit down and determine that $3,000 a month would allow you to cover your mandatory expenses, your emergency fund should be in the range of $9,000 to $18,000.
On a sidenote, here’s a question that I’ve gotten frequently: Where should you keep your emergency fund? Well, there are two key considerations for your emergency fund: it should be kept somewhere that is both safe and liquid (available quickly). I can hear you now. “Well sure, safety and liquidity are important, but I want my money to grow while it just sits there.” Understandable—I do, too. But please, hear me when I say this: when it comes to your emergency fund, growth is secondary to safety and liquidity. I’ve heard from far, far too many people who are considering putting their emergency fund into the market. Not only is this a bad idea, it is antithetical to the purpose of an emergency fund. Why? Well, if you’ve failed to keep your emergency fund both safe and liquid when you come to call on it, you run the risk that it won’t be there for you—and your emergency fund is designed to reduce your personal financial risk, not increase it.
“…when it comes to your emergency fund, growth is secondary to safety and liquidity.“
Back to the question at hand. Where to keep it, then? Some of the best options that are both safe and liquid, and still offer some growth, are:
- High-yield savings accounts (HYSAs)
- Money market funds/accounts
- Short-term certificates of deposit (CDs)
Granted, much has been made of the current interest rate environment (upon which all of these options are highly dependent), and how there aren’t many good, safe options today that also allow for much growth. This is true…but, again, I would urge you to consider growth secondary to safety and liquidity. Shop around, and do the best you can. My wife and I currently hold 20% of our emergency fund in a savings account at our local bank for liquidity, and the remaining 80% in Vanguard’s Federal Money Market Fund (VMFXX) for a little additional growth. Both places fulfill the requirements of keeping it safe and liquid. Leave a comment below, and let me know your emergency fund strategy! How many months’ expenses is it? Where do you hold it?
Now that you have a fully funded emergency fund, it’s time to look at an equally important consideration prior to investing: your debt position. In Part 2, we will cover why investing with certain forms of debt makes zero sense, how to evaluate your debt sources, and a very effective strategy for tackling it.
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Love the start – and love how each blog continues to capture the readers attention! Great work, Sean!