The Boring Money Move That Can Save Your Mental Health
When we talk about the importance of money, we often focus on building wealth and spending money on things that make you happy.
But, the most important and least-discussed reason to care about personal finance is to protect your mental health.
We all know money—or a lack of it—is a major source of stress and one of the leading causes of divorce.
If you’ve ever read a book on personal finance, then you’ve likely been told that having an emergency fund of cash set aside is the most important financial goal when you begin managing money.
Typically, you hear arguments focusing on the financial benefits of an emergency fund.
In this article, I review the findings of a 2022 research paper that show that having an emergency fund is not only a good way to protect your money but also your mental health—especially if money is tight for you right now.
The two primary causes of financial-related stress
Almost every financial headache you will have in your life will come from one of two sources.
One of the questions the researchers wanted to answer was which of these sources of financial stress had a greater impact on people’s subjective financial well-being, which measures how positively or negatively people feel about their lives and finances.
They found that the impact of an income shock was more than twice as large as an expense shock on subjective well-being.
When your fridge or car breaks down, that can be very stressful.
In the summer of 2022, me and my family went on a 2-month trip to Nova Scotia (where I am from). When we came back home, we found that our fridge had died, and due to supply chain issues happening at the time, it took over a month for our replacement fridge to arrive. It was an inconvenience and caused some stress despite us having the cash on hand to buy the new fridge. If we did not have cash to buy the fridge, it would have caused a lot more stress.
But, expense shocks like coming home to a broken fridge are typically one-off events, which makes them more manageable both financially and emotionally.
Income shocks are a different beast.
Losing your job or having your hours cut back can make your entire financial life feel like a house of cards that is collapsing in on itself. The longer you experience a decline in income, the easier it is for your brain to trick you into believing that this loss is permanent and that you will fall from your current financial position you worked so hard for and will never climb this high again.
As I have written in the past, the #1 factor that impacts every financial decision you make—and how you feel about it—is your income.
It’s a simple truth and is no genius insight on my part.
But I am constantly amazed at how often we focus on trivial financial issues like buying a cup of coffee over the handful of issues that drive our financial lives, such as income, housing costs, and the decisions of whether and how to invest.
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How to build financial resiliency
The second question the researchers wanted to answer was how people could build financial resiliency, which means reducing the impact of financial shocks on their well-being.
This study measured how access to liquidity—which is your ability to quickly get cash in your hands when you need it—impacts the subjective well-being of low and middle-income households when they experience a decline in income or an unexpected and large expense.
They focused on three different forms of liquidity
People who experienced an income shock and had a below-average amount of cash in emergency savings experienced nearly double the negative impact on their well-being compared to those with an above-average amount of cash savings.
It turns out that having cash set aside to cover expenses in a financial emergency works. Not only is an emergency fund a logical financial move—it’s a great way to protect your mental health and preserve your resilience during tough times.
The big problem is that low-income households are the least likely to have an emergency fund in place. In the absence of cash, many people turn to credit cards to cover their living expenses when they’ve experienced a decline in income or an unexpectedly large expense.
As you might have guessed—this typically ends badly. Financially, it’s easy to fall into a debt spiral where relying on debt can easily lead to continuing to rely on debt as interest payments pile on top of your regular expenses.
Somewhat surprising was that those with access to credit cards experienced a much steeper decline in well-being after a financial shock than those who did not have a credit card. For some people, using credit to pay the bills brings more misery than not paying the bills at all.
Those people who had a strong social network and could borrow money from friends and family were able to better weather a financial shock compared to those who didn’t have access to a social network. Knowing that you have people in your life who love you and you can rely on them to help you when you need them does wonders for your resilience. Knowing you’re not going through life alone is a beautiful thing.
But, relying on social networks can be dangerous. For a one-time event, having family and friends who can help you can be a great thing. However, research and common sense tell us that the more often you rely on friends and family to help you financially, the more strained those relationships can become. Eventually, a one-sided financial dependency can destroy that very social network and become a strain on your emotional well-being.
Emergency funds are the foundation on which you build your financial house.
If you don’t have an emergency fund right now, correcting that should probably be your #1 financial priority.
Don’t do it because it’s what personal finance writers tell you it’s a good idea—do it because it can have massive benefits to your mental health during tough times.
Can you think of a time when having access to an emergency fund—or borrowing money from friends or family has saved you a massive amount of stress?
A version of this story was originally published on my Substack, the home of my writing. As a token of gratitude, existing readers can get 75% off their first year’s subscription.
This article is for informational purposes only. It should not be considered Financial or Legal Advice. Not all information will be accurate. Consult a financial professional before making any significant financial decisions.