When it comes to financial priorities, most experts agree that it’s smart to save money and build an emergency fund before you focus your efforts on investing.
However, there is a such thing as over-saving, says Bernadette Joy, money coach and founder of Crush Your Money Goals. Joy, who paid off $300,000 in debt in three years and now has a net worth of $1 million, says some of her clients save much more than they need to.
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“They are over-padding when they could be investing instead,” she says. Once you have an adequate emergency fund, you might want to consider redirecting additional contributions into an investment account to build wealth over the long term.
How much is it smart to save in an emergency fund
Most financial experts, including Joy, agree that it’s smart have 3 to 6 months worth of living expenses saved. Suze Orman, bestselling author of “Women & Money,” told Grow that the pandemic highlighted how Americans probably need to save even more.
“The truth of the matter is, it’s probable that you should have one year of an emergency fund right now,” Orman said at the height of the pandemic.
This isn’t easy to do. More than half of Americans, 51%, have less than three months’ worth of expenses in their emergency funds, according to a 2021 Bankrate survey. Of that 51%, a whopping 25% have no emergency fund at all.
When people save, they are over-padding when they could be investing instead.
Founder of Crush Your Money Goals
To save up enough money, you can automate your savings and follow a budget or the 50/20/30 rule where you allocate 20% of your income to savings and investing, 50% to fixed expenses, and 30% to flexible spending.
Once you build up what you think is an adequate emergency fund, though, you don’t need to keep contributing to the savings account, Joy says. Instead, focus on investing, which has associated risks but also potential wealth-building benefits: “Cash is not going to do you any good if it’s not growing.”
‘Starting as early as possible’ is best
Because markets can go down as well as up, investing works best over the long term. That’s why it’s important to start early.
It doesn’t matter if you can’t invest a lot, Mark La Spisa, a certified financial planner and president of Vermillion Financial Advisors, told Grow. “Starting as early as possible, even if it is only a few dollars, is better than doing nothing or waiting until you accumulate a significant amount,” he said.
This is thanks to the power of compound interest, which is the interest you earn on your money, plus the interest it’s already accrued.
A classic example from the Federal Reserve Bank of St. Louis shows the power of compounding. The saver who starts earlier ends up with a bigger savings balance at age 65, even though her later-starting friend ultimately contributes three times as much. The extra decade of compounding growth put her ahead. Remember, though, investing involves risk and examples like these do not take into account the fact that markets can go up as well as down and that can affect the value of your investments.
If money is in a savings account earning very little or no interest, it can’t grow. But if you invest in a retirement account like a 401(k) or a Roth IRA, your money can work for you.
The article “‘Self-Made Millionaire Money Coach: Don’t Make This Common Mistake With Your Emergency Fund” was originally published on Grow (CNBC + Acorns).
Original Post: cnbc.com