An Emergency Fund Can Help Protect Your Long-Term Investments

by Donald C. Schultz

As an investor, you likely have some ambitious financial goals: perhaps funding college for your kids, a vacation home or some extended travels, and, most importantly, a comfortable retirement. But your progress toward these long-term objectives can be slowed considerably by short-term financial needs — and that’s why an emergency fund is crucial.

What type of short-term financial needs might you encounter? A new furnace, a new roof, your car’s transmission, your kid’s braces — the list goes on and on. And if your normal cash flow isn’t enough to meet these expenses, you may be forced to dip into your IRA, 401(k), brokerage accounts or other investment vehicles. By doing so, you might incur fees, penalties and taxes — especially if you withdraw from tax-deferred accounts that are designed to help you save for retirement. 

But by tapping into these investments, you would also incur an even bigger cost — the opportunity cost. That is, by taking money out of these vehicles, you would decrease their value today — and thereby end up with a smaller platform for tomorrow’s growth opportunities.  

Of course, people who “borrow” from their long-term investments to pay for short-term needs promise themselves that they’ll quickly repay these accounts. But that’s not the easiest promise to keep, given the day-to-day expenses we all face. 

Consequently, to help protect your long-term investments and allow them as much growth potential as possible, you should set up an emergency fund containing six to 12 months’ worth of living expenses. (Generally speaking, the closer you are to retirement, the larger the emergency fund you’ll need.) 

When you create an emergency fund, the key word to remember is liquidity. You need a fund that gives you immediate, penalty-free access to your money. You probably already have that type of liquidity in your regular checking and savings accounts, but it’s best to keep your emergency fund in a separate vehicle – one that you won’t touch for everyday expenses. For example, a money market account. The point isn’t to earn a return; it’s to protect your principal from market volatility and to be easily and quickly accessible for withdrawals. 

Six to 12 months’ worth of living expenses might sound like a lot to put away, and it can be if you try to do it all at once. Instead, strive to build your emergency fund gradually by contributing whatever you can afford each month. To help yourself along, you may want to have money automatically moved from your checking account to your emergency fund.

You might be pleasantly surprised to see how quickly your account can grow. And once you have a solid emergency fund established, you’ll be able to face unexpected expenses with more confidence (and hopefully less stress) than before. Best of all, you’ll avoid draining your long-term investments — which means one less hurdle on the road to achieving your financial goals. 

This article is provided by Donald Schultz, a Financial Advisor at RBC Wealth Management. The information included in this article is not intended to be used as the primary basis for making investment decisions. RBC Wealth Management does not endorse this organization or publication. Consult your investment professional for additional information and guidance. Asset allocation and diversification do not assure a profit or protect against loss.

Investment and insurance products offered through RBC Wealth Management are not insured by the FDIC or any other federal government agency, are not deposits or other obligations of, or guaranteed by, a bank or any bank affiliate, and are subject to investment risks, including possible loss of the principal amount invested.

RBC Wealth Management, a division of RBC Capital Markets, LLC, registered investment adviser and Member NYSE/FINRA/SIPC.