Why This Common Account Shouldn't Be Your Emergency Fund

Don't gamble with your rainy day fund.

Maintaining an adequate emergency fund is one of the cornerstones of a healthy financial plan. But keeping it in the right place is just as important as having the cash in the first place. Read on to learn more about the pitfalls of saving your emergency fund in an active brokerage account.

What is an emergency fund?

Most financial professionals agree that keeping an adequate emergency fund should be your top personal finance priority. An emergency fund can help hedge short-term risks, such as the loss of a job, an unexpected expense, or a higher-than-expected tax bill. By keeping a designated emergency fund, you can free up the rest of your savings to be invested for the long term.

But how much of an emergency fund is enough? Most experts agree that an adequate emergency fund should cover three to six months of non-discretionary expenses. Non-discretionary expenses are necessities such as groceries, rent or mortgage payments, transportation costs, and insurance premiums. It is important to note that your emergency fund should be large enough that you can sleep comfortably at night, feeling protected from the unexpected.

Don't keep it invested in a brokerage account

The point of an emergency fund is to provide isolation between your day-to-day finances and the general trends of the overall economy. If the worst were to happen, say a stagflationary recession, you might lose your job while being on the hook for rising expenses. And when you try to access your actively invested emergency fund, you might find the market crashing and the value of your safety net diminished. The short-term fluctuations in the stock market make it a dangerous place to keep your financial lifeline -- and make it harder to sleep at night.

You should be able to access your emergency fund just as quickly as an emergency can strike. After all, what's the point of saving for an emergency if your money is tied up in a financial institution when you need it most? An invested emergency fund will take time to access -- first you must sell whatever security your fund is invested in, then you need to wait two days for the funds to settle, and possibly wait a few days for the funds to be transferred to your bank account. In an emergency, you likely won't have that much time. The best test of an emergency fund is ease of access, a test that an active brokerage account fails.

Try these instead

In order to be effective, your rainy day fund must be stable and accessible. Instead of keeping your savings in a volatile and inaccessible brokerage account, consider keeping it in a different type of account.

Many advisors recommend keeping emergency funds in a traditional bank account. While this vehicle may not be the sexiest, cash in a savings account is typically available instantly. And because your emergency fund is kept in cash, you will always know exactly how much money you have in case of the worst.

Alternatives to the traditional bank account include high-yield savings accounts and money market accounts. Both earn higher interest on your emergency savings, and similarly avoid swings in value. Be aware that some high-yield savings accounts and money market accounts are less accessible than traditional bank accounts. In the world of emergency savings, the speed with which you can access your money is of the utmost importance.