Emergency fund can help protect long-term investments
Provided by RBC Wealth Management
and Dave Dupont
As an investor, you’ve probably got some ambitious plans: college for your kids, perhaps 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 you need to establish an emergency fund.
What type of short-term financial needs might you encounter? Take your pick: A new furnace, a new roof, your car’s transmission, your kids’ braces … And if your normal cash flow isn’t enough to meet these expenses, you may well 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 those accounts that have received tax-deferred status because they’re designed to help you save for retirement.
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 to allow them as much growth potential as possible, you’ll need to set up an emergency fund containing six to 12 months’ worth of living expenses.
When you create an emergency fund, here’s the key word to remember: 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 you need to keep your emergency fund in a separate vehicle, one that you won’t touch for everyday costs. You might, for example, consider a money market account. You won’t earn much in the way of a return, but that’s not the point; your principal won’t be affected by the ups and downs of the financial markets, and you can quickly and easily make withdrawals.
Six to 12 months’ worth of living expenses might sound like a lot to put away, and it is — if you try to do it all at once. Instead, strive to build it gradually by contributing whatever you can afford each month.
You might be pleasantly surprised when you see how quickly your account has grown. And after that, you’ll be able to face those unexpected expenses with a lot less stress than before. Best of all, you’ll avoid draining your long-term investments.
This article is provided by Dave Dupont, a Financial Advisor at RBC Wealth Management. RBC Wealth Management does not endorse this organization or publication.
RBC Wealth Management, a division of RBC Capital Markets LLC, Member NYSE/FINRA/SIPC