It’s one of the oldest financial tips around, and one of the most revered. It’s one that almost all financial experts will give their clients, and most of those clients will follow blindly. The reason is that, on the outside, it seems to make perfect financial sense. The fact is however, this venerable tip could be costing you hundreds of thousands of dollars in interest.
What is this tip? Is the one that says you need to have an emergency fund of 6 to 12 months put aside for, well, emergencies. Since it needs to be “liquid”, it’s recommended by most financial experts that you put this money in a regular savings account. (And, to be perfectly honest, we’ve recommended it here on our blog many times.)
Again, it seems to make perfect sense. The fact is, getting through life without an emergency or two is practically impossible. Unexpected things happen, which usually cost a few dollars and, in some cases, a lot more than a few dollars. The HVAC system suddenly goes out, your spouse breaks a leg and can’t work or the car needs a major repair job.
If something along these lines happens, having that emergency fund is going to seem like a godsend. That is, until you take a look at the numbers over 35 years.
Let’s take a married couple in their 30s as an example. They do their due diligence and determine that, in order to have a well-funded emergency fund, the need to put $75,000 aside. They do so and, once that emergency fund is all set, they go about their lives and even feel good about the excellent financial decision they’ve made.
The only problem is that, if they put that money into a regular savings account (as most financial experts will suggest) over the next 35 years they’ll lose up to $1 million.
The reason; the poor rate of return in the savings bank as opposed to a diversified investment portfolio.
The difference, if you compare 1% interest rate to an 8% investment return, over 35 years, is just over $1 million.
By stashing that $75,000 into a savings account instead of investing it, our young couple has denied themselves the benefit of 35 years of compound interest on their money.
Now, many of you are asking “well, what about that emergency fund were supposed to have?”
The fact is, there are a number of other ways to put aside money for emergencies that, when you need it, won’t cost you anything in early withdrawal fees or taxes.
- A 401(k) loan. In many cases you can withdraw up to 50% of your 401(k), up to $50,000 maximum without any penalties In some cases, a 401k can even be rolled over into a Gold IRA as well. For Gold IRA rollover step by step instructions check them out online, it’s fairly easy.
- A home equity line of credit. If you own a home and your mortgage is in good standing, a home equity line of credit will allow you to write checks in an emergency
- Credit cards. While not a perfect solution, if you have good or excellent credit, using your credit cards to get cash in an emergency is one of the quickest ways to do it
Now, here’s the thing. Having an emergency fund is not a bad idea because, frankly, it’s vital that every person has access to a source of funds that they can access quickly in an emergency. On the other hand, keeping that emergency cash in a savings account returns practically nothing and interest, a definite waste of your money’s potential.
The take away from all of this is simply that putting a large amount of cash aside in a savings account is an ill-advised financial tip. Keeping a few thousand dollars there is okay but putting the rest into a better type of investment is a much better idea and, in 35 years, you’ll end up with quite a bit more cash.