Our family has been out of debt for a while now, and one of the first things we did after dumping all of our debt was to increase our $1000 emergency fund to better be able to cover us in case of larger emergencies, not just small emergencies.
First we built up a 6 month reserve in our savings account. After we had built up 6 months in reserve, the economy had already tanked and my wife had quit her job to become a stay at home mom, so we decided that we’d like to bump up our reserves to cover 12 months of expenses instead.
We’ve now saved up that 12 month emergency fund, and we feel pretty secure should I lose my job or have another major health issue. One thing that we have thought about, however, is if we should invest a portion of our emergency fund?
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Where Emergency Funds Traditionally Go: Savings, Money Market
When you read up on the traditional advice on where to put your emergency savings you’ll get some very conservative answers, usually ranging from a liquid checking, savings or money market account. Some will say to keep a small emergency fund of $1000 or more in your local checking. Next keep the rest of your emergency fund in a savings account earning the best interest that you can get. In this interest rate environment that is typically no more than 1% or so. Not much to write home about.
We’re currently using this strategy with $1000 in a local checking account, and then the rest of our 12 month emergency fund in an Ally Bank savings account. The money in that account is earning less than 1% right now.
CDs Or A CD Ladder
Some people suggest taking a different strategy where you keep a few months of savings in your local checking and online savings accounts (like 3 months), and then putting the rest of it in a CD Ladder where you’re earning a bit more on the money, while still leaving the money available within a few months if you really need it after your 3 months of savings in your liquid accounts. Another idea is to put the money in CDs that have smaller penalties for withdrawing early – in case you need to. For example, Ally has a 2 month interest penalty for early withdrawal, while others can have penalties upwards of 6 months interest. Be sure to check.
Investing In The Stock Market
Some people think that investing in the stock market with a portion of your emergency fund can be a good plan. Just make sure that you do have enough liquid funds (like 3-6 months) you can access right away, and then invest the rest, with the assumption that you could lose some of that principal.
One of the best options that I’ve heard of is to use your Roth IRA as a place to put some of your emergency fund. Since you can withdraw your contributions without penalty with a Roth, that can be a legitimate option for emergencies that crop up that won’t create unnecessary penalties or tax burdens.
Investing in a more liquid stock investment like Betterment.com or through another brokerage account where you can withdraw your money at any time can also be an option. Just remember that you could be forced to sell at a time when the market is down cementing losses, or creating taxable earnings.
I think the biggest thing you have to contend with here is the risk that is inherent in the stock market, where you could in fact lose a large portion of your money at any time. So is that really something you want to do with emergency funds that you really want to be there and be liquid?
Investing In Lending Club
Another place that I’ve heard of some people investing a portion of their long term emergency cash is at Lending Club.
Typically Lending Club investors can get somewhere in the neighborhood of 9-12% returns depending on how much risk they take on. While the returns can be pretty good, the funds you’re putting with Lending Club are typically going to be in 3-5 year loans, so the money isn’t terribly liquid if you need the money right away. You can always sell the notes on the secondary market, but you may end up losing quite a bit that way. You also have the risk of borrowers defaulting on their loans, although you can pretty well diversify your risks with Lending Club.
If I were to head down this road, it would only be with long term emergency funds, and not money I would need right away.
Our Current Strategy
I am by nature pretty conservative when it comes to our emergency funds, and I currently keep all of it liquid in either a checking or savings account, earning around .90% interest. While I’d like to be earning more interest on the money, I just like having that money there and available should we need it – and I think my wife also needs it even more than I do to have that sense of well being. If I were to put a big chunk of it in some sort of investment I don’t think she would have as much peace of mind.
Going forward I think we’ll continue our strategy, but if we build up and above the 12 months in savings, we may end up investing a portion of that somehow. I’m not sure how we’ll do that quite yet, but we’ll see.
What are you thoughts? Would you ever invest a portion of your emergency fund? Why or why not?
Good article Peter – I’ve never thought about doing this, but its definitely something to consider! Especially if you have a larger emergency fund.
Minor correction on Lending Club liquidity. You can always sell your Notes on the secondary market (FolioFN). That is actually a large part of my strategy.
I actually mentioned that you can sell it the notes on the secondary market but that sometimes there is a risk of losing money doing that.
I might consider a CD-ladder if I got above 1 year savings, but the rates are low for that also now.
I still say it’s worth putting a small amount in a Roth IRA. Choose a lower-risk investment. It’ll grow and grow, and it’ll be there if you have something catastrophic come up.
I took a big chunk of our emergency fund and put it into a 5 year Ally cd at 2.5% last year. If I need the money it only costs me 60 days interest. Even if I need it after a year, the adjusted rate is still better than a 1 yr cd after the penalty.
I consider cds as savings, not investing. The stock market is for investing and not a good place for your emergency fund money, in my humble opinion. Great topic to bring up Peter.
Yeah whatever you decide, I think you are smart for keeping it in something that you could get your hands on it immediately if you needed it. I am currently working on getting to a 3 month emergency fund. You gotta start somewhere. :-)
I think it’s important to remember what the emergency fund is there for: to cover unforeseen expenses immediately. Therefore, I’m going to keep my emergency fund in an easy-to-access checking account where it’s no problem getting it right away, and no risk of losing it.
I suppose we are fortunate in some ways to be living in Thailand. Our emergency fund is sitting in a savings account here earning 2.65%. Otherwise I might consider a CD ladder for the portion of emergency savings that wouldn’t be needed for at least 3 months. I would keep the first three months worth in a savings account though for easy access.
I wouldn’t consider savings above 12 months of living experience (or even 6 months for most people not self-employed) as an emergency fund. At that point, I have separate savings accounts or investment accounts earmarked specifically for a financial goal (house down payment, etc.) I wouldn’t invest an emergency fund in investments that aren’t immediately liquid if needed.
Once you cross over into risky assets your money is no longer an emergency fund. If you put 1/2 of a 12 month emergency fund in risky assets then you only have a 6 month emergency fund!
Have people thoughts about using a short-term bond index fund? Vanguard has a low cost fund, can be tax-free if you like, and comes with a checkbook so you can write checks on it should an emergency come up. These funds have a 3-4% annulaized return and only a small risk of principal risk.
Great job, Peter, on saving 12 month emergency fund. I say you should define when enough emergency fund is enough and start investing everything above that amount while keeping your defined emergency fund in a savings account.
Yeah, that’s pretty much what we’re doing.
An emergency fund is just that. Investing in the stock market seems like a bad idea since you would most likely need your emergency fund when the economy is in a slump. Bank of Bolivar has a great checking account that earns 2.97% interest when certain qualifications are met. Check it out at http://www.bankofbolivarmo.com/home/services/checking#ultimate. Also look at my ideal portfolio at http://sheldontoler.blogspot.com/2012/02/many-people-consider-investing-their.html.
I think Sheldon makes a good point that the stock market might tend to be in a slump at the same time that you need your emergency money, but I’m not sure how likely that is.
At the same time I can’t imagine ever needing my entire $15k emergency fund immediately available for cash withdrawal in an instant. Maybe in a kidnapping ransom situation in the movies, but not here. I like the idea of keeping a few thousand ($3k-5k) in an FDIC savings account that can be accessed in a pinch, but any more than that and it hurts me not to do something more productive with it. I mean the whole point of having a 6 month emergency fund is that you can use it for those 6 months that you need it, right? In which case I don’t mind it being slightly less liquid. I can handle 5-10 days of processing.