The other day an emergency room nurse told me that she had to pull money from her 403(b) fund to buy appliances. She had recently had a significant power surge due to an electrical outage that fried the circuits of her refrigerator, stove, and microwave. She’s never truly felt (until now) the importance of having an emergency fund.
Although it’s been preached across multiple financial advice mediums the importance of an emergency fund, this sacred but simple step in financial independence often gets overlooked. And in this case, we’re not talking about someone who couldn’t build an appropriate emergency fund.
This nurse has told me she has made over $200,000 this year (which includes her overtime). She is in her 60’s, owns her own home which is paid for, and doesn’t have other significant financial responsibilities like supporting others.
Yet despite this, she has had to tap into her retirement accounts when she is nearing actual retirement for herself.
Why Is This?
Well, the answer is probably very diversified depending on whom you talk to. Personally, I feel that it’s probably because emergency funds are boring and feel like a wasted use of money.
Rationally, we all realize the importance of having a 6-8-month emergency fund. But we’re talking a bit of money here. For some this could reach into the tens of thousands of dollars. And the money just sits there. Accumulating next to nothing in interest.
Boring.
But in this boring case, it’s costing this nurse about $10,000 from her retirement account (because she had to take out extra to account for annual taxes while also earning a hefty yearly income).
This nurse is close to retirement (she still wants to work for 5 or more years) and this still affects her significantly. If she was in her 30s, however, the compounding loss of this money is even more profound.
Compound Interest
Pull out $10,000 from your retirement account when you’re 30 and you’re potentially losing out on 35 years of compound growth of that money.
Doesn’t sound like a lot?
Well, let’s run some numbers. If you averaged a 10% annual return in your retirement accounts, this 10k could have potentially turned into a whopping $280,000!
That’s a lot of money you missed out on for some appliances today because you couldn’t pay for it from emergency savings!
I know some of you financial nerds say the market doesn’t consistently return this amount and you would be right. But if she even makes 7% on her investment it could have reached over $100,000!
Those are very expensive appliances when you consider opportunity costs.
What’s A Better Plan?
The better plan is to build up this emergency account first. And then the goal is to keep it intact. Now, there are a lot of options out there to play with. For some people, they like to get an initial $1,000 to $5,000 in an account then work on their investments.
Others will be more diligent and go for a goal 6-8 months of living expenses before they invest.
For myself, I like the idea of starting a decent savings account first then drip feed it, so it grows larger with monthly automatic contributions from your paycheck. These can be small additions – even if it’s $50 bucks a paycheck, it will slowly grow your account while you start investing. But don’t ignore this account, it’s important!
The consistency of automatic contributions (provided you don’t dip into your account) are amazing.
The bottom line is that you need some sort of emergency savings. The bigger, the better.
Finally,
It’s still very important to have a large emergency fund, boring as it is. The years of 2020 – 2021 proved the need when people across our nation were losing jobs or forced out of work for months on end.
But if you just have to invest, build that fund to a decent size so you can handle the smaller emergencies that can come along (like a power outage destroying your kitchen appliances) and continually add to it.
It’s important to realize early on that an emergency fund is essential. With consistency, you’ll have those 6-8 months of living expenses taken care of and the peace of mind from having this safety account will not be boring at all, but something you truly cherish and protect.
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