Interest rates are rising. The financial landscape is changing. It’s becoming easier to make money from our cash. These changes in interest-rates have inspired me to update my emergency-fund strategy. Here is my mission statement:
My goal is to transform my emergency-fund from a liability of $20,000 cash that is losing value to inflation every month, into an asset that makes me money each month. After all, one of the greatest insights I’ve ever heard on how to build wealth was this quote by Robert Kiyosaki:
“It’s the compounding of assets, not just money, which creates true wealth.”
To summarize that point: To create true wealth, I need to collect as many assets as I can get my hands on. My new goal is to invest part of my emergency fund so that it becomes a new cash-creating asset in my portfolio. Below are the steps I am taking to invest my emergency fund to make more money in our post-recession, higher-interest rate world.
My Past Emergency Fund Strategy:
In order for me to explain how I’m going to improve my emergency-fund strategy, I need to tell you how I’ve managed my emergency fund in the past. For the last four years, my local bank only offered a .01% APR (Annual Percentage Rate) on the cash I held in my savings account. There wasn’t a lot of money to be made with that .01% interest rate, so I decided to hold 6-12 months of expenses in my local banks low-interest savings and checking accounts.
I decided my emergency fund should be $20,000 because that’s the number I felt safe and secure with. Being self-employed means that I have more financial risk in my life than a normal W-2 employee. I could lose a huge client, or my business could fail overnight due to forces outside of my control like a plummeting economy. A year’s worth of expenses saved in the bank helped me feel confident that I could find new clients, or find a new job, if my sales dried up. $20,000 was just a magic number that made me feel comfortable in my day-to-day financial life. So for the last 5 years, keeping $20,000 in my savings account has been the norm for me.
This strategy worked well for me when interest rates were ultra-low. If you do the math, .01% on $20,000 is only $2, so it’s not like I was missing out by keeping this money easily available in my local bank. But now that interest rates are rising, banks are offering higher-interest payments if you store your money in their savings accounts. I recently realized I can start making money off my emergency fund if I hold it in the right bank. So I have decided it is time to update my emergency-fund strategy so that I can start making money on my cash, and turn my emergency fund into another asset in my portfolio.
How I’m Going to Invest my Emergency Fund: The Research.
I started my research by searching for alternative banks that offered savings accounts that paid a better interest rate than the horrible .01% annual rate my local bank offered. I was looking for a safe, stable, and convenient place I could put this money, which would still allow me to access it quickly in an emergency. These were my top three favorite accounts I found:
Ally offered a savings account with a 2.0% APR.
American Express offered a savings account with a 2.1% APR.
Vanguard offered a money market account (VMMXX) with a 2.45% APR
As you can see, they all offered a great alternative to my .01% savings account. So let’s look at the pros and cons of each one, and which one would be the best investment for me to store my emergency fund in.
Ally Savings Account: Currently offering a 2.0% interest rates.
I first became familiar with Ally Savings Accounts, when I attended the financial-blogging conference, Fincon last year. Ally threw an incredible outdoor party at a local bar with a BBQ buffet and a band. It was an extremely fun and memorable event. While there, I talked to a few big-time money bloggers there who used Ally for their high-interest checking and savings accounts and they were very happy with their product and service. That memorable experience, and customer reviews, put Ally’s offerings in my top 3 finalist. Their savings account was also FDIC insured. Their only drawback for me was that they weren’t offering the best interest rate (see American Express and Vanguard below), and since I’m not already a customer of Ally’s, I’d have to open a new account with them, and I don’t want to spread my money all over the place if I don’t have to.
American Express Savings Account: Currently offering a 2.1% interest rate.
I didn’t know American Express even offered savings accounts until I started searching for high-interest savings accounts. I was surprised to see that American Express offered a FDIC insured savings account with an interest-rate that topped Ally’s by .10%. The American Express savings account was attractive to me because I already have an American Express card, so it would be easy for me to expand my working relationship with them.
Finally, I dug into the account that paid the highest-interest rate:
Vanguard’s Money Market Account (VMMXX): Currently offering a 2.45% interest rate.
Vanguard’s Money Market Account (VMMXX) isn’t a savings account like the above two options. It’s actually an extremely conservative mutual-fund that is traded under the symbol, VMMXX on the New York Stock Exchange. But it’s different from “normal” mutual funds, because it maintains its value like money in a savings account does. Unlike most mutual funds, Vanguard’s money market account (VMMXX) doesn’t decrease in value when the stock market decreases in value. And it pays a 2.45% interest rate on the money that is held in there.
The down sides of Vanguard’s VMMXX is that you don’t have immediate access to the money you invest in this fund. In order to retrieve your money in this fund, you’d have to sell your shares of VMMXX (which hold at a constant $1 per share no matter what the stock market does) and wait for a few days for that money to then be deposited into your bank account.
This investment fund was an attractive option in my new emergency-fund strategy, because it paid the highest interest rate among it’s competitors (2.45% monthly), and I already have an account with Vanguard. However, another down-side to this fund was in the little disclaimer I found at the bottom of the fund’s description that read:
“You could lose money by investing in the fund (VMMXX). Although the fund seeks to preserve the value of your investment at $1.00 per share, it cannot guarantee it will do so. The fund may impose a fee upon sale of your shares or may temporarily suspend your ability to sell shares if the fund’s liquidity falls below required minimums because of market conditions or other factors. An investment in the fund is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. The fund’s sponsor has no legal obligation to provide financial support to the fund, and you should not expect that the sponsor will provide financial support to the fund at any time.”
Realizing that this money-market fund isn’t FDIC insured was a scary detail at first because my primary goal with my emergency-fund is to NEVER lose any money during a time of an emergency. But after doing some research on it, I realized there are firm guidelines Vanguard has to honor to their clients who invest their cash into this fund. (You can see the terms of this fund by clicking here.)
After reading this document in full, I saw that at worst, an investor in this fund can be charged a 2% fee, and up to 10 days to get their money out of this fund. In an absolute worst case scenario, losing $200 and waiting 10 days to get my $10,000 in an emergency wasn’t that frightening to me, because I would almost NEVER need my cash within 10 days. I have credit cards I can get by on, and even if I needed to get $10,000 out of this fund, I still plan to carry 2 months of emergency cash in my checking account to pay my monthly bills.
In the end, I realized this account would best solve my needs. It would allow me to invest a large chunk of my emergency fund ($10,000) and it would pay me $294 annually (2.45%) to hold my money there. This scenario fulfilled my desire to transform my emergency-fund from a liability that was losing money to inflation, into an asset that would start paying me a couple hundred bucks a year. For these reasons, this fund became my #1 choice to invest a big chunk of my emergency fund into.
My Final Plan to Update my Emergency Fund Strategy:
Finally, after all that research, I had to stop being a student in a controlled classroom. I had to become an active investor, take a leap of faith, make a decision, and invest some money in my emergency fund and learn what works the best by trial and error. I finally decided that my updated emergency fund strategy will be a collection of these three accounts below.
The First Emergency Fund Vault:
The first vault that I will store my emergency-fund savings in will be my checking account at my local bank. I will use this account to pay my monthly bills. I plan on keeping 1-1.5 months worth of cash in there.
My checking account won’t have the benefit of making me any money, but it won’t lose me any money either. It will allow me to easily access my cash easily as the bank is only a half mile from my house. On average, I need about $4000 per month to pay my monthly bills which includes two mortgages. Just to be safe, I’ll probably keep an extra half- month of cash in there to avoid overdraft fees or an expensive month. So my emergency-fund going forward will have between $4,000 and $6,000 worth of cash in my checking account at my local bank. We’ll try this, and adjust as necessary.
The Second Emergency Fund Vault:
The second vault that will hold my emergency-fund savings will be $10,000 worth of Vanguards VMMXX Money Market shares that will start paying me 2.45% interest on the cash I store there. This portion of my Emergency Fund will now become an asset and start paying me $294 per year, or around $25 of passive income per month. This backup $10,000 will help me sleep deeply at night because I know I have around $15,000 in cash laying around that won’t go down in value if the stock market drops or an emergency comes up.
The Third Emergency Fund Vault:
The third vault that will hold my emergency-fund savings will be my Vanguard brokerage account, which currently holds 100% of vanguard’s total stock market index fund, or VTSAX.
I currently have $11,000 stocked in there in case an emergency or an awesome can’t-miss investment opportunity pops up. One of my investing goals in the next 2 years is to build this account up to have a value of $30,000-$50,000 worth of shares, which will act like a backup to emergency fund strategy. Since I should never need this money immediately, I can afford to invest it into higher-performing stocks. This investment will be higher-risk, but it will also provide me a potential higher return. This is what investors call their F-U money. Once I have $50,000+ stored away in these three emergency-funds, I’ll have a couple years worth of expenses stored up before I have to tap into my other vaults of cash which are my retirement accounts and real-estate equity.
Considering this blog is starting to profit me around $1 a day in April 2018, I am confident that I can build it up to making me at least $100 a day in 2 years. So for me, I’ve started to see my emergency fund as having two purposes in my life. One purpose is to act as a financial buffer between me and the harsh realities of life. It’s second purpose is to act as a financial bridge to my next goal in life which is to turn this blog into a full-time lifestyle business, which I hope to do in the next 5 years.
In conclusion, in the next year, I hope my updated emergency-fund will look something like this pie-chart below:
Considering our monthly spending (without any major emergencies or entertainment splurges) is around $2,000 per month, my new updated emergency-fund strategy should provide me around 2+ years of financial cushion to figure out what to do next if a financial emergency does happen in my life.
I also like that the risk associated with each account will be structured in three tiers: low, medium, high. The lowest-risk account (Checking) will be the money I keep closest to my daily needs. The slightly-higher return account (Money Market) shouldn’t be needed until I run out of money in my checking account. And the highest-risk/highest-return account (Total Stock Market Index) shouldn’t be needed until I run out of 6 months worth of money in my first two accounts.
Will this be enough money? Am I right, or am I wrong? I’m a DIY investor who learns by trial and error, so I am always looking for advice. In the end, this is how I am going to update my emergency-fund strategy for 2018, and I’ll let you know how it goes.
What’s your strategy with your emergency fund?
Please share your thoughts in the comment section below so that you can inspire someone reading this after you! (Anonymous comments are fine.)
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I agree with getting better returns than most brick and mortar savings and loan banks. We have a big chunk for a house saved in Vanguard Municipal Money Market. We in a high tax bracket hence the municipal. I know its a risk, maybe more than your MMA, but if the MM tanks, were all in trouble. As I understand it, the $1 stability of MMA is akin to the US gvmt not defaulting on bonds. Both are essential to the financial system.
I like your strategy of keeping some at risk in the market, but I’d probably sleep better just losing those gains and keeping it safe. Maybe as rates rise you’ll feel ok putting that market money into federal bonds instead.
Hey Good Life! I just got back from a 4-day trip to New York City. You’re advice to check out Federal Bonds for a better return really piqued my interest, and I look forward to researching the positives of bonds, as bonds are one area I don’t know a lot about. I plan on updating this post every year, which is why I put the 2018 date in it, so maybe when I update it for 2019, I’ll have a section in there about bonds, thanks to you!
Billy,
The Money Market, if that’s what you mean by federal bonds isn’t really bonds. It’s ultra short term lending kept at value of a dollar and charged a Big interest for use of the money. I use municipal money market from vanguard so these are mostly not federal if any, but rather issues by municipal governments for airports, sewer roads etc. of the highest credit rating.
Welcome back from NYC, good times.
~GLMD
I’m confused, at one point in the article you mentioned you need $4k to cover each month’s expenses, but then you said your monthly spending is around $2k a month.
I was just trying to follow your math regarding how many months of expenses you consider important to hold in an emergency fund. Thanks!!
Hi Samantha. I was in New York City the last few days with my wife, and comments weren’t forwarding to my phone, which is why I didn’t respond sooner. Anyways, that $2000 gap you noticed between my “monthly expenses” and “monthly spending” is there because of my rental property mortgage. I’ll probably add a sentence explaining the difference into the post now that you mentioned it. On the first of each month, I have a $980 mortgage bill auto-drawn from my checking account. But on my lease with my tenants I have a grace period of 5 days for them to pay rent, and sometimes they pay on the 2nd, 3rd, or 4th, so during that 5 day grace period I may have $1000 more expenses than income until their $1600 rent check is deposited.
Also the other reason I said $4000 monthly expenses, is because I was rounding up to a more comfortable number. We can live off $2000 a month, but that’s REALLY on a tight budget. And we like to go to the occasional weekend road trip, movie, restaurant, or do a house project which pushes our “normal” monthly spending to about $2500-$3000, and then with the rental mortgage, our monthly spending is about $4000, even though we get $1600 of it back on the 5th when rent is paid. We only live on $2000 per month if it’s really a super frugal month for a focused reason. Hope that makes sense to you, and I’ll be adding a note to the post explaining that gap.
That makes sense! I just thought it was a typo, haha.
Thanks for the review on your plan. It’s helpful and timely. I’m looking to put my ~6 months of expenses somewhere earning more than my .15% in my USAA savings (that percentage is for $10k+).
I’m heading into a career change and need to keep cash handy but I’m getting more confident I won’t need it so I don’t want it just gathering dust (i.e. loosing value). I still need to figure out what feels right for me but I am pretty sure I’m going to go heavier into VTSAX because I also have access to a HELOC at Prime + 1% that would cover over a year of me at zero income if my checking account balance couldn’t cover and stocks were wildly down.
Hey Billy – looks like you have a really well thought out strategy. Nice work! If you wanted to chase a little higher yield for just a little more work, you should check out Insight, Mango, and NetSpend accounts. All pre-paid accounts that can pair with a 5-6% APY savings account and all are FDIC insured. Financial Panther did a nice write up on Insight here: https://financialpanther.com/insight-card-5-percent-interest-savings/
I like your plan. I have been looking to do more with my emergency fund too. It looks like VMMXX has a 0.16 ER. Doesn’t that make American Express the better option? I love Vanguard though. There are admiral shares (VMRXX) that have a 0.1 ER. Nice post!
I noticed that too, but I’ve read in online forums that the .16 ER is taken out before the 1.69% APR is paid, so you still get the 1.69% APR, so I’ll find out this year if that’s true. Also, I noticed the admiral shares too (VMRXX) and even tried to buy them thinking the minimum investment was $5,000 which is not a problem for me. However, look at the minimum investment number more closely. It’s actually $5 MILLION dollars!!!! $5 million dollars is a little out of my ballpark for an emergency fund. Haha.
By the way Shawn, I just called Vanguard to double check and they agreed with my above statement. The .16% expense ratio on Money Market Accounts is already factored into the yield they advertise, so you don’t have to factor that expense ratio into the advertised yield of the fund.
Just wondering why you should have kept the amount to freezer for five years when there were options for better return than the APR you got!? Just curious.
Which amount are you talking about? The $20K I kept in my checking account before I invested it into the VMMXX? Two reasons: 1) Interest rates have been super low for the last 8ish years, so I didn’t have alot of motivation to try to find a .1% better return on that money. 2) I was too busy figuring out how to invest for bigger returns, like the 20%ish return I get on my investment property, and the 7% return I will hopefully get on my stock returns. Now that I have that money working for me, and those investments figured out, I thought it was a good time to return my energy and focus to see how I could make some more money off my emergency fund in this higher-interest rate world. This was the plan I came up with. I do plan on updating my plan each year, as I am sure my plans will change as interest rates and needs will change. (Also, I wasn’t interested in investing in CD’s or anything that locks my money up, as I enjoy investing in real-estate, and since I never know when an undervalued home, duplex, or triplex comes on the market, I want to be able to have access to enough for a down payment.) Does this answer your question? Thanks for commenting.