Should I Have an Emergency Fund Before I Invest?

Most financial experts agree that you want to have some sort of emergency fund set up before you start investing. The reality is that unforseen expenses such as medical bills, home repairs, and unemployment do arise. If you don't have liquid funds available for these emergencies, you may have to tap into your investments to cover them which is never ideal.

Once you have an emergency fund established, it does not make sense to keep placing dollars there. Instead you should start diverting dollars towards your investments. In general it is recommended to have 3 to 6 months worth of expenses in your emergency fund, but we will look at how much you really need before you can start investing later on.

Step 1: Figure out the total amount you need

Your first step should be to figure out the total amount you want to have in your emergency fund. As stated before, you want to aim to have between 3 and 6 months worth of expenses saved up. You can list out your total monthly expenses and multiply that by 3 or 6 to give you an good estimate of what you should have.

Step 2: Break it down to a monthly goal

It will be easier to reach your larger savings goal by breaking it down into smaller monthly goals. Review your budget to see what you could contribute to your emergency fund. Once you figure out that amount, we recommend setting up automatic deposits so you are not tempted to spend the money.

Step 3: Store your emergency fund in an accessible account

The whole point of an emergency fund is to have the money readily available when unexpected expenses arise. For this reason, one of the best places for your emergency fund is a high yield savings account. You can earn a higher interest rate than a standard savings account, while still having access to your money when needed.

Although saving 3 to 6 months worth of expenses is the standard, do you really need to wait until you reach this to start investing? The short answer is no. Say for example that you make $50,000 per year after taxes. If you wanted to save 6 months of expenses, or $25,000, it could take years.

So, when exactly can you start investing? The short answer is that it varies person to person. If you have kids, and a mortgage you should probably have a larger emergency fund built before you start investing. If you are single, you can get away with a smaller emergency fund. Aim to have between $500 and $1000 saved up before investing.

In general, as long as you have a liquid amount in your emergency fund that you are comfortable with, you can start investing. Remember, an emergency fund is not an investment. It is there to stop you from going backwards. Once your emergency fund is at an amount that allows you to sleep easy, start diverting your dollars towards your investments so you can build long term wealth.

The bottom line is that everyone should have some sort of an emergency fund before investing. Although saving 3 to 6 months of expenses is a good target, the exact amount you need will vary person to person. Don't get so fixated on reaching the 3 to 6 months savings goal that you forget to invest. Remember, an emergency fund is not an investment. It is there to make sure you don't go backwards from unexpected expenses.