Emergency funds are undervalued until they are not. The pandemic sheds the financial spotlight on people prepared and not. In all fairness, there is a difference between being prepared for income interruption or an unexpected expense and having an entire economy close. Regardless, there are things we can do to prepare for the next “surprise.”
Assuming you have taxable income, a great way to save for an emergency is inside a Roth IRA. Unlike traditional tax-deferred IRAs, Roth IRA contributions have already been taxed, and that contribution is accessible at any time without penalty.
Think about your house like you would if you were running a business. The value of the home matters, the retirement accounts matter, but you also have to have the cash-flow to pay the monthly expenses. More businesses go under because of liquidity – not being able to cover short term obligations – than do because they have no assets.
The Roth IRA is liquid, and the growth can be as well, depending on the use of the funds. The investments inside the Roth account can be cash that is completely liquid or stocks that endure market volatility. We recommend that you have access to three months' worth of emergency funding or liquidity, but that can come from multiple sources.
Cash will always be king in a crisis. Either you will need it for your own issues, or you can use it to buy assets from others at a discounted price. That cash can be inside a Roth IRA or a bank account.
There have been people who argue there is no reason to use a Roth IRA if you aren't going to invest the assets. Disagreeing is not a strong enough way to state my opinion on the matter.
There are times my 401k, for instance, holds more stocks than at other times. Market conditions drive our investment decisions. The IRS dictates the amount we can contribute to IRA's and 401k's. Your choice is how to invest those dollars.
If you need an emergency fund today, then you can keep the investments more liquid in the Roth IRA. In future years you can invest those dollars in stocks or bonds if you so choose. If you don't fund your 401k or IRA this year, the IRS will not allow you to go back, and makeup missed years.
Regularly, families will come to our office with cash in an account that they have no intention of using. It is an emergency fund. They also haven't funded a Roth IRA because they didn't understand the money was accessible in an emergency, and they never realized they could conservatively invest the Roth.
Using your resources correctly requires paying attention to the tax code, investment opportunities, and possible needs in the future. You always want to hope for the best and be prepared – within reason – for the unexpected necessity from liquidity. LIfe comes quickly, and cash can go fast. Be prepared!
Disclaimer: Joseph Clark is a Certified Financial Planner™ and the Managing Partner of Financial Enhancement Group, LLC an SEC Registered Investment Advisor. He is the host of “Consider This” found on WIBC Saturday mornings from 6-7a.m. as well as three other Indiana-based radio stations. Joe has served as an Adjunct Assistant Professor at Purdue University where he taught the capstone course for a degree in Financial Counseling and Planning.
Financial Enhancement Group is an SEC Registered Investment Advisor. Securities offered through World Equity Group, Inc., Member FINRA/SIPC, and a Registered Investment Advisor. Investment Advisory services offered through Financial Enhancement Group (FEG) or World Equity Group. FEG is not owned or controlled by World Equity Group.
Joseph Clark and World Equity Group, Inc. do not provide tax or legal advice. For tax advice consult with a qualified tax professional. For legal advice consult with an attorney