One of my friends asked me what to with some side money that he has? He was wondering whether he should put it into a savings account, into an S&P500 Index Fund, buy individual stock options, or buy a piece of rural land? What would be the best thing to do with the side-money?
Firstly, congratulations on having some side-money. I think that is a great thing. It is the first step in building up a solid financial foundation. Before we answer the question “What would be the best thing to do with the side-money?”, we should ask a couple of questions to make sure there are no near-term obligations that we should be mindful of. Some example questions are:
- Do you have sufficient emergency funds?
- Do you have any near-term expenses, like paying taxes, buying a car, fixing a car, paying a security deposit for an apartment?
- Are you saving up for a tool that can help you make money, this tool can be a car, a computer or a phone, etc?
All these questions are to help you understand your financial needs and their perspective investment horizons. Investment horizon is the total time period that you are expecting to “not touch” this money. The longer your investment horizon is the greater risk you can take on. This is because you have a longer time period for your investment to recover and appreciate in value. The shorter your investment horizon is, the less risk you should take on.
Now, that’s talk about an emergency fund. An emergency fund is the same as a rainy day fund. You want to set aside some savings to buffer you against some negative changes to your financial situation. These negative changes can be a loss of income due to layoffs or firing, a serious illness, or a massive home repair. In any of these situations, your emergency fund can help you reduce the financial stress coming from these events.
As a result, you should keep about 3-6 months of your monthly expenses set aside as your emergency fund. How do you find out your monthly expenses? Add up your rental expense, grocery expense, restaurant and transportation expenses, utilities, student loan payments, and any other recurring expenses, and you can get a rough estimate this way. If you do have the ability to set aside some money every month, still consider putting together an emergency fund.
Ideally, your emergency fund should be in a low-risk, highly liquid asset class. Since you won’t be using it on a daily basis, you should consider having your emergency fund in a high-yield savings account, a certificate of deposit, or a money market fund.
Okay, I personally use a Nationwide Axos Online Savings account to get more than 1% APY on my emergency fund, but there are a lot more options out there. Check out NerdWallet’s recommendation for high-yield savings account.
Originally published on criticalingredients.com
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