The Smartest First Investment I Made Wasn’t Stocks, It Was My Emergency Fund.

One of the most common questions that I get asked and see being asked on public forums is, “I want to invest, how should I start?” Getting started with investing is quite straightforward these days; in fact, it’s always been that way. But just because you want to invest does not mean that you should jump in straightaway, especially if you are someone who wants to build long-term wealth.

When I see this question, I see a lot of suggestions about different investment instruments, ranging from fixed deposits to private equity and VC funding. But the first thing that comes to my mind, and something I personally advise, is to build an emergency fund first. And this is exactly what I did when I started my investing journey as well. It’s not about chasing exceptional returns; it’s about protecting yourself when life throws you an unexpected curveball. Let me explain.

What is an Emergency Fund?

An emergency fund is a dedicated pool of money that you set aside in a safe, easily accessible account to cover unexpected expenses or loss of income. Think of it as your personal financial safety net, which would come in handy when life throws curveballs at you. This is not something you use for your day-to-day spending, but rather is kept aside exclusively for emergencies. And a good rule of thumb is to have enough funds to cover 3-6 months of your essential living expenses. But you are free to decide how much runway you need in case of an emergency. Personally, I wanted to have a longer runway, so I wanted to have at least 12 months of essential expenses.

Think of it this way, it’s like the helmet you put on when you want to ride your motorbike. Of course, you can ride without your helmet, but if you get into an accident, you will be thankful that you had your helmet on.

Why Does the Emergency Fund Matter So Much?

The importance of an emergency fund is clear because life is unpredictable, and emergencies do not wait for your investments to grow. A sudden medical bill, or you lose your job, your car breaks down, and it’s a costly repair, these can happen any time without any warning, and you are forced to scramble for money.

Protect Your Investments from Early Liquidation

If you start your investments without an emergency fund, you face the risk of early liquidation and also the risk of being forced to realize losses on your investments. Imagine a medical emergency that would cost you a large sum of money, and the only way to pay the money back is to liquidate your investments, and if the financial market is in a downturn, the impact on you is worse.

When something like this happens, it will often ruin your returns, you will incur losses, and most importantly, it will discourage you from investing again.

Keeps You Away from Falling into Debt Traps

Without an emergency fund, your only option during an emergency might be to use a credit card, personal loans, payday loans, or borrow money at insanely high interest rates. When this happens, debt builds up fast, and instead of you building your wealth, you now need to start focusing on digging yourself out of the hole you are in. This is never a good place for someone to be.

Puts Your Mind At Rest

An emergency fund will give you assurance that you are covered when you need money the most, and having that assurance is one of the greatest feelings. You don’t need to stress about money immediately; you are ready for a sudden job loss or a sudden large expense without worrying. You keep your head clear, and this will make you a better investor.

Scenario

You are a working professional who is keen on investing and has your excess money invested in the Stock Market. You keep a small amount of money in a savings account as a buffer in case you have additional expenses, and the rest is invested in the stock market. Due to unforeseen incidents, financial markets across the world are crashing, and it’s impacting you as well, as your stock portfolio has an unrealized loss of 30%. But as an investor, you are not worried; you know the market will recover, and you are building long-term wealth.

Suddenly, one of your close family members becomes ill and requires surgery to save their life. The surgery needs to be done immediately, and it will cost a large amount of money. At this point, you are forced to make a decision: should I borrow money, or should I liquidate all or a portion of my stock portfolio to perform the surgery?

Both options will either land you in debt or force you to liquidate your portfolio at a loss. This is why you need an emergency fund.

Do I Really Need to Build the Emergency Fund First Before Investing?

I’m sure you must have this question in your mind now. And my answer is Yes and No. Let me explain.

Ideally, yes, you should build your emergency fund as your foundation first. That is the safest approach you can take. This gives you all the assurances we talked about before you get into serious investing.

But you can do what I did as well. It’s a bit risky, but it’s a balanced approach as well. The approach I took was to allocate most of my excess money towards building the emergency fund, and the remaining I allocated for different investments. And I adjusted the percentages when I got close to my target. For example, I started with 80% allocation to my emergency fund and 20% allocation to investments. And when I reached my 12-month essential expenses goal, I adjusted the amounts to 40% towards the emergency fund and 60% towards my investments until my emergency fund reached the desired amount that I was comfortable with.

I felt this was the smarter approach to take since this way, significant funds are still going into your emergency fund, but you are learning and investing in other investment instruments at the same time.

Where Should I Put My Emergency Fund?

There are different ways to keep your emergency fund. You can keep that money in a savings account, but that is not ideal. There are other great options that you can use. One of the best ways to keep your emergency fund is to use a Money Market Savings account or a Money Market Fund. These will give you higher returns than a typical savings account, but also have fast liquidity similar to a savings account, so you can access your money quickly if needed. But keep in mind that most of these Money Market Savings Accounts have an entry requirement of about 500,000 LKR, so if you don’t have that already, keep your money in a savings account until you reach the required limit and then move to a Money Market Account.

You can also use low-risk, fast liquidity unit trust funds as well; these funds will mostly invest in government securities and corporate debt. These typically have slower liquidity compared to a Money Market Savings or Fund, but you can access the money within 24 hours in most cases. And these yield slightly higher rates of return than Money Market Funds/Savings Accounts.

My Personal Recommendation

I took a hybrid approach to building my emergency fund. This was mainly done to maximize the return and also have fast liquidity if required. What I did was I split my emergency fund between a Money Market Savings account and a low-risk Unit Trust fund.

25% of my emergency fund is stored in a Money Market Savings account at my bank. This gives me super-fast access to my money when I need it, and it’s enough to cover most emergency needs that I have.

The remaining 75% of the emergency fund is stored in a Low-Risk Unit Trust fund that invests in government securities and corporate debt. This gives me higher returns with an acceptable level of access to my money, and I can take the money out within 24 hours. This is there in case I need most or all of my emergency fund.

This balanced approach of allocating my emergency fund money gives me flexibility with fast access to my funds in an emergency, as well as maximum possible returns while I maintain the funds.

Summary

Your emergency fund is not optional, it’s the foundation of financial security. It protects your investments, shields you from debt, and gives you peace of mind to invest confidently for the long term.

In my view, an emergency fund is fundamental to anyone who wants to build long-term wealth and become a good investor. It’s one of 2 foundational advice that I give to anyone who is starting their investing journey. (The other one is writing down your income and expenses). The peace of mind an emergency fund provides and the way it helps you preserve your investments in an emergency are undeniable.