401 K Plan or Emergency Fund?

Now consider these sobering statistics:

41% of Americans can handle a $1,000 emergency

37% would be forced to use a credit card

Are Americans saving the wrong way? Conventional wisdom says that from day 1 of your career, start investing in your 401 K plan, putting back as much as you can. If the pandemic has taught only one thing, it might be to throw conventional wisdom and the financial textbook out of the window.

When you are first starting, there are three habits that are most important to develop. First, giving back to God. Second, living within your means. Finally, develop the habit of saving. If you can master those three disciplines, you have set a solid foundation. The problem is we were never taught the importance of establishing an emergency fund. So, we put that on the backburner as if we are immune to having unexpected emergency expenses show up.

The new conventional wisdom is to make sure you have the short-term taken care of before you start preparing for the long-term.

Put off the 401 K plan until you have saved up enough money into your emergency fund. If you think about it, saving for the long-term never made sense when the short-term was not handled. The only exception is when the employer is matching your contribution. If you can save enough money to do both, take advantage of the free money by contributing up to the point you get the full 100% match! If you can't successfully do both, I would prioritize the emergency fund.

Now, where do you hold your emergency fund? First, you keep it in a boring money market or savings account where you can get your hands on it. You don't want to invest it. Second, since savings and money market accounts are paying hardly anything interest wise, go for convenience versus trying to get the highest interest rate. You want to have a straightforward process set up to fund your emergency fund.

Having a fully-funded emergency account not only gives you some security, it also will keep you out of debt. After all, the credit card is the replacement when you don't have an emergency fund set up.