Every day, well-meaning couples have to make a financial decision: Should they focus on rebuilding their emergency savings or keep saving for retirement?
We recently faced this exact situation at home. After using our emergency fund for a down payment on a new house, we now have a sizable gap to fill. This presents a problem because every extra dollar we make is intended for our goal of retiring by age 45. Plus, saving in tax-sheltered accounts can lead to significant financial benefits over time.
So, why am I prioritizing rebuilding our rainy day fund and putting additional retirement savings on hold? There’s a good reason! Let’s weigh the two choices to see why one might be more advantageous.
Just to clarify, we’re not completely stopping our retirement savings. We’re still putting a lot into our Roth IRAs and 403(b) plans, and I’m contributing enough to my new 401(k) to get the full employer match. My approach to financial freedom has always been to max out our tax-sheltered retirement accounts. This strategy is how many people, like Robert and Robin Charlton in the book “How to Retire Early,” manage to retire in their early 40s. By maxing out IRS limits, you not only accumulate capital quickly but also save thousands in taxes each year.
One common criticism of having a large rainy day fund is that it doesn’t generate much interest. Why keep over $10,000 in a savings account that earns less than 1% interest? That’s only about $100 in a year. Invest that in a stock market index fund, and you could potentially earn 8 to 10% annually. Over several years, this could mean missing out on significant earnings.
Previously, I even debated investing some of our emergency savings in a semi-stable mutual fund. It seemed logical to invest a small portion in assets like bonds and money market funds. However, I lost about $100 when I cashed out. In hindsight, that 1% interest savings account was the better choice.
Having a substantial rainy day fund might not yield high returns, but let’s consider the bigger picture. What if you didn’t have an emergency fund? When trouble strikes, like a car breakdown, the quick fix is often a credit card. It’s fast and easy but leads to high interest rates—anywhere from 15 to 30%—if you can’t pay off the balance immediately. This scenario quickly spirals into debt.
Without a rainy day fund, you’re essentially facing an opportunity cost. Your emergency fund could save you from 15 to 30% in future interest payments. That’s the real value of having that emergency cash.
While a rainy day fund may not bring direct earnings, it can prevent serious financial costs. That’s why I’m focusing on rebuilding our emergency fund before worrying about extra retirement savings. Once our emergency savings are at a comfortable level, we can resume our aggressive retirement savings plan. For now, the focus is on preparing for any unforeseen expenses, which could save us from hefty credit card interest rates down the line.
