Emergency savings:
The importance of having accessible savings has been highlighted time and time again, however for investors and savers, emergency savings really is an essential tool on the journey to financial independence. There are two very important reasons why having 3 months' salary saved and accessible is vital to any investor and saver:
Reason 1: Debt.
At some point in our lives, we will need some extra cash for an unplanned expense, halt in the economy or a job change. Without having some extra funds put away, debt becomes one of the solutions in covering these unexpected expenses. More debt results in higher interest expenses, reducing monthly cash flow that could be invested or saved.
Where funds are needed quickly, short term expensive debt instruments are typically utilised. Shorter forms of debt such as credit cards, overdrafts and short-term loans carry the highest interest charges. We are also in an environment where interest rates are increasing, meaning borrowing expenses are rising. What may seem a small insignificant borrowing at first, may result in large interest expenses down the line and a halt in contributions to long term investment and savings vehicles.
Reducing debt, especially short-term expensive debt is a clear path to reaching financial independence. Having emergency savings in an easily accessible vehicle, means not having to increase debt balances or turn to expensive debt solutions when money is needed on short notice. This will keep you in a strong financial position going forward by eliminating additional short term interest expenses from your financial journey.
Reason 2: Allowing savings and investments enough time to perform.
Staying the course and allowing assets enough time to perform is a tried and tested investment and savings strategy. Should an emergency arise, and funds withdrawn from long term vehicles, you eliminate the upside of those assets increasing in price as well as interrupt compounding:
Markets have been volatile recently; however long-term investing and saving is about seeing through short term volatility with long term sustainable returns in mind. Selling assets early could mean exiting at an unfavourable time in the market meaning buying high and selling low. Having extra funds available when needed means not having to sell or exit assets prematurely, giving yourself all the upside when asset prices increase.
Reinvesting returns allows the power of compounding to take effect and grow a portfolio substantially. Compounding accelerates long term growth, and over the years can result in a much larger capital nest egg. Returns from investments as well as interest from savings instruments when reinvested over time allows for bigger returns to accumulate. Withdrawing long term investments and savings to fund shorter term expenses means eliminating all compounding that is still to take effect, interrupting capital growth.
In closing:
What may seem an insignificant amount at the time, could result in a much larger capital balance over the long term, and its why it is important that investments and savings are left to grow and are not withdrawn early for emergencies. Having that accessible emergency fund available means never having to interrupt long term investment and savings or incur expensive short term debt expenses. Make emergency savings part of your investment and savings toolbox.
