We need help with our emergency fund.
Not to reach our goal of $25,000 before the end of the year. I think we’re actually going to be ahead on that (you can see details in our budget report coming Wednesday).
The question is where to put the money.
Right now, our emergency fund earns 1.0% interest in a Capital One savings account. That’s nowhere near the heady days of the 5.5% interest you could earn on a savings account in 2006, or the 10% interest in 1987, but it’s more than the near zero rates we’ve seen since the recession.
The problem is that inflation is about double that–projected at 2.5% in 2018 and 2019. It’s true that our $25,000 will increase one percent over the year to become $25,250. But if everything costs 2.5 percent more, it will cost $25,625 to purchase what is worth $25,000 today. With our interest rate lower than the inflation rate, we’re actually losing $375 of purchasing power.
We’re thinking about putting the emergency fund into a Capital One money market account, which currently earns 1.6% interest. At 1.6% interest, our $25,000 becomes $25,400 in a year, so we’re only down $225 of purchasing power each year. That’s better, but it still means we’d need to contribute about twenty dollars a month to just keep from losing value in our emergency fund.
We could find slightly higher rates at a few banks, but for a minimal rate increase, it might not be worth it. It’s really convenient to have all our savings accounts in one place. It’s also nice that opening the money market account and transferring the money would take two minutes and require no paperwork. We’ve had accounts there for nearly 15 years (starting back when it was ING Direct) and creating accounts and transferring funds has always been a matter of a few clicks.
So, friends, what do you suggest? What’s the best place to put our emergency fund? There are really only two rules. It has to be somewhere we can reach it easily and quickly–you know, in an emergency. It also has to be somewhere safe. If the stock market crashes and the economic stress takes our jobs, we don’t want our emergency money to have been in the stock market, erased with our income stream.
I know, asking for safe money and higher returns at the same time is hard. Maybe 1.6% is the best we can reasonably do. But maybe it’s not. I suspect we’re not the only ones with this question, so a discussion in the comments could be helpful for pretty much anyone with emergency money set aside somewhere.
What’s your best advice? Where do you keep your emergency money?
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Keep a lower tier (a few thousand) in a cash equivalent – a savings account (Ally is paying 1.6% last I looked), money market, etc. Put the rest into CDs. You can probably find a decent rate. You’ll be able to access it quickly but pay an early withdrawal penalty, and in the more likely case that you don’t need the second tier you get a better rate.
Also consider rotating the money into I-Bonds, which pay a real return (inflation plus the stated rate); you can withdraw the money anytime after the first year, so this is something you wouldn’t do all at once.
Thanks for taking the time to reply Mike!
It looks like Ally and Capital One are both paying 1.6% on their respective savings and money market deposit accounts. Ally applies this to every account, and Capital One only to accounts of at least $10,000. Smaller accounts get 0.85%.
Funny thing though. While Ally and Capital One are showing pretty much equal CD rates, Ally has a balance requirement for the highest rate and Capital One applies the highest rate to any balance. As of today (June 4) these were 2.25% for 12-month CDs, 2.35% for 24-month CDs, until at 60-months Ally pays 2.6% and Capital One pays 2.8%.
On the other hand, the early withdrawal penalty is tiered at Ally (smaller for shorter term accounts) and fixed at six months of interest at Capital One. If only one bank could agree to be the best at everything, it’d make these decisions really easy.
I really like the idea of I-Bond. Self-adjusting inflation-protected savings exactly addresses our question in the original post. Right now they’re offering 2.52%, which beats all but the 5-year CD rates at Ally or Capital One. I think we might consider rolling a portion of the emergency cash in over time, since there’s a 12-month period where we couldn’t withdraw at all.
So look at that! If we go from a full $25,000 at 1.6% (per the original post) and just put $7,500 into a 1.6% cash equivalent account and the remaining $17,500 into a 2.35% 3-year CD, our blended interest rate jumps to 2.125%, which about keeps us up with inflation.
If the worst thing happens and we have a true emergency before the three years is up, we break the CD open early and pay $206 in early withdrawal penalty. Or we ladder the CDs and get a little lower blended rate and a little more liquidity, and add some cash into I-Bonds to get started with inflation protected savings.
Not a bad deal at all. Treat yourself to an ice cream sundae, or if you’re in town, I’ll treat you to one.
IIRC, you’re down in California, and I don’t get down there too often. (We’re up in Washington.) But if I do, I might take you up on that! Happy to help. 🙂
I’d check out your local credit unions. The ones I have looked into (both physical and online) have savings and CD rates that are much better than most banks. We keep some in savings and some in a CD.
Thanks MH. I grew up with a credit union account and that was my first thought too. The first place I looked was at our local credit unions. I couldn’t find one that paid over 0.7% for a cash-equivalent account or over 2% for a CD. That’s better than the local banks, but online banks like Capital One and Ally seem to really be pulling ahead on interest rates.
So far, I think a savings or money market deposit is the best place for some completely liquid cash that we need in a hurry, with a second tier deposited in a higher-earning account to help keep up with or beat inflation. We’ll let you know exactly how we end up splitting the money, where we put it, and why we decided here in the near future.
We try to keep around $20,000 to $30,000 in our savings account, and anything above that we transfer into an assortment of Vanguard ETFs. We diversify in line with our investment profile (we are both fairly comfortable with risk, which helps.) You can find quizzes on-line to help you determine your risk profile; if you aren’t both on the same page then you’ll have to work out a comfortable compromise.
Don’t be afraid of the stock market. Sure, it goes down, but if you ride it out, it always goes back up. Bonds are very secure, though, if stocks scare you.
It can take about a week to get funds out of Vanguard. That doesn’t bother us – worst case scenario we can put it on our credit cards. But it may be a consideration for you.
Thanks Anon (for this). I’m completely with you on the stock market. Stephanie and I both have Vanguard accounts where we’ve rolled in old 401ks and consolidated our traditional and Roth IRAs. Our long term investment strategy is pretty simple — buy and hold low-cost index funds at Vanguard, and don’t worry about what happens in the short term.
For the more focused question of our $25,000 emergency fund, we’re looking for something beyond the savings account that at least keeps up with inflation. We appreciate all the comments, both here and in email, with advice.
I don’t think we’ve ever talked in any detail about investments or net worth on the blog, but we’ll get around to it. Posts on the blog mostly follow our own family finances as Stephanie and I discuss topics that we think might be interesting or useful for folks following along. With student loans repaid and our home on accelerated repayment, investments might be showing up more often.
We probably do have too much cash in the bank. We do want to gradually bring it down to around $10,000; but at the moment there are a few things we’re working towards doing, so we want to have easy access to the cash. As for keeping up with inflation, we aren’t really worried about that, because the return on our other investments is well ahead of inflation. The stock market isn’t doing fabulously well these days; but with dividends, we’re still ahead.
My/our emergency savings is considerably smaller, but I have it in an 18 month CD ladder at 3 month rungs with Capital One. (our Disneyland savings is with a credit union since they were offering a special 2.2% on 14 months.) It’s unlikely that an emergency would require more than one or two rungs if we needed to break it, and depending on the timing/amounts we could even float it on a credit card until the next one matures. It doesn’t quite keep up with inflation, but it was the closest I could get while also balancing liquidity and safety.
Thanks Cath. It sounds like you’ve reached a good balance. With at 12-month CD at Capital One currently yielding 2.25%, building a CD ladder there makes a lot of sense. The rates on 6-month, 9-month and 18-month CDs right now are surprisingly low, so we’d add another CD every 3 months and build the ladder over a year.
It would take a real (and really big) emergency for us to need more than 25% of our emergency fund cash at once, so 3-month rungs are absolutely reasonable. In the unlikely case of a real emergency, the penalty to break out the cash prematurely would be a negligible cost, while the likely interest earned in all those months we don’t have a real emergency would about keep up with inflation.