Introduction

Investing as a means to financial freedom has always been known, but over the past couple of years, it has become even more popularized with more liquidity in the economy and more people aspiring to retire early. I first learned about investing when I was 11, but was only able to begin my journey in university when I landed my first coop internship. One of the first things I learned was the concept of having a safety net called an Emergency fund. This was a fund that if all things went wrong, provided you with a buffer to handle unexpected emergencies without having to dip into the money you have put away into investments. I understood it in theory, but it wasn't until I started investing that I realized the importance of it.

In this article, I'll share a personal anecdote to help drive the importance of having an emergency fund before you begin your investing journey

Emergency Funds; Who needs that?

It was 2015, and I had just landed my first coop internship where I was earning about $20/hour. I was super exicted since this was my first taste of reliable income that was guaranteed (as long as I didn't get fired). I had read all the books I could find on how to pick stocks, how to distribute your assets between stocks and bonds based on risk tolerance, e.t.c. I was still in school as an international student, but fortunate enough to have a combination of scholarships and help from my parents to pay all of my international tuition fees. So I knew that some of the money I earned from this internship could be put directly into investing. I had broken it all down. After taxes, I would be making about $9600 for the 4-month internship. Acounting for personal expenses at that time, minus $6000 that I wanted to pay towards my tuition for the upcoming semester, I calculated that I could put about $2000 directly into my investment account.

After the internship ended, I had saved up exactly the amount I calculated for investing, so I opened a margin account with Questrade, and deposited the money into my account. I've always been an Apple fan, so the first and only stock I bought was Apple. At that point in time (January 11th, 2016), their share price was about $97/share (accounting for the latest 4-1 stock split in August 2020, the adjusted share price at that date was about $24). I was super excited to own Shares in a Company I loved. I remember checking the share price almost every day that passed. There's something really exciting about taking charge of your one financial journey, however small the step may seem.

A few months later, an emergency came up. I was able to take care of it with money I had saved, but this reduced my disposable cash to zero. I wasn't able to pay my monthly rent or even feed myself. Having no where else to get money from immediately, I was forced to sell my Apple shares at a small loss, and withdraw all my funds. I couldn't justify going hungry in order to hold on to Shares that weren't instantly producing any returns that I could use to take care of my personal expenses. My reasoning here was that there was most likely going to be another emergency that would arise, so it was more prudent to hold on to cash so I could easily take care of them when they did arise. No other emergencies came up fortunately, but I didn't have the discipline to put money back into investing, so I spent the rest of my funds on insignificant things that I don't remember.

Looking back on this, I don't even remember what exactly the emergency was, but what has always stuck with me is the cost of handling emergencies.

The Cost of handling Emergencies

When I say the cost of handling emergencies, there are two ways to think about it. There's the actual cost, and then the opportunity cost of using money that was meant to be working for you to pay someone else. Let's break it down a bit:

• At the time of writing (October 15th, 2021), a share of AAPL is $143.77
• If I had first created my emergency fund which for me as a student was 3-4 months of personal expenses, I would have had about $1500 for emergencies and $500 that I could comfortably use to buy shares in Apple.
• When the emergency arose, I would have been able to handle it using the emergency funds I had stowed away without having to reach into my investment funds.
• With $500 worth of Apple shares at $24/share, I would have owned 20 shares of Apple. Which at todays price would be worth $2875.40 (20 * $143.77). That's roughly more than 5X my initial investment!

I didn't have this much foresight back then unfortunately, so in today's value, the cost of that emergency is:

$1500 (actual cost) + $2875.40 (opportunity cost) = $4375.40

That's a really expensive emergency!

However, I'm glad I got a chance to experience this lesson eariler in my investing journey. I still have the occasional emergencies that pop up here and there, but I have never needed to reach into my investment funds.

How to setup an Emergency fund

The last thing I'd like to address is how to actually go about setting up an emergency fund. Everyone's needs are different, but you want the amount in your emergency fund to answer this question:

If something unexpected happend where I lost my job and couldn't work, do I have enough to take care of 6 months of my current important lifestyle expenses.

The time frame could range from 3-12 months. When I was a student, I mostly planned on a per semester basis which was about 3 months. Now, my emergency funds time frame is 12 months. I have these funds stowed away in a high interest savings account making it easily accessible when needed.

You also want to be careful to properly define what constitutes as an emergency. Quality of life expenses like dining out or shopping shouldn't be taken into account when considering what should be categorized as emergency expenses.

Finally, if you ever end up having to dip into your emergency funds, be sure to top it back up. Your future you will thank you!

Conclusion

When investing, compound interest is your ally. The longer you leave your money in your investment, the larger your future payout. I liken taking money out of investments to handle day-to-day or emergency expences to harvesting crops before they even mature to bear any fruit. Setting up an emergency fund will help you stay in invested longer which will in the long run, always increase your future payout.

Thanks for reading!