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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