Do You Put Your Emergency Fund To Work? – Part 2

This is the second part of a three part series. The other two parts can be found here:

Just a quick refresher in case you missed the first part and are unwilling to quickly read it over 🙂

The bank I hold my emergency fund has closed down. I have since moved the money from that account to my savings account but I want to find a more suitable home for it. The money is my emergency fund, so there are certain requirements that have to be met by any investment or account that it sits in. Those requirements include:

  • Liquidity: I must be able to access the money within three weeks time.
  • Risk: The investment must not fluctuate more than 10%
  • Simplicity: The money has to stay together in one investment and be simple to change or access.

Yesterday I went over a couple viable solutions, and today I will finish those solutions with the ones I am leaning more towards. They are less conventional for an emergency fund, but they do come with benefits.

Most of the options below encompass using a Roth IRA as an investment vehicle. The advantages to a Roth IRA are; everything contributed is after tax money; contributions can be withdrawn without any tax penalty, at any time; and any growth in the Roth IRA from investments is tax free but cannot be withdrawn without penalty till the age of 59 and a half.

Putting my emergency fund into a Roth IRA, I have the option of investing in individual stocks, mutual funds, index funds or even target date funds.

Moderate risk, moderate return and high liquidity, plus tax advantages: Roth IRA + Index fund/Mutual fund

Just glancing at my brokerage account, and their branded index funds, the total return for this year is an average of 17.44% between four different funds. I would have the option to invest in any fund from my Roth IRA, even those not affiliated with the bank that houses the IRA.

This option is more risky than just planting the money and getting a 17.44% return. The market fluctuates drastically from time to time, and the ten year return on these funds is closer to zero. Using this approach, I would have to actively watch the market, and make sure my investment was always within my 10% risk threshold.

The time frame for this is about one business day. I would have to sell any securities I hold, and then just move the money from my Roth to my checking which is with the same bank, therefore instant.

This option also includes mutual funds, which are actively managed leading to a higher expense ratio, and slightly lower average return, just looking at what my bank offers in house. I don’t plan to use mutual funds where index funds are available but they are an option.

Low risk, moderate return and moderate to low liquidity, plus tax advantages: Roth IRA + Short-term bond fund

Bond funds are new to me so bear with me as we explore this option.

A bond fund is an fund that invests solely in bonds, in this case specifically short-term bonds. The type of bonds this fund holds include commercial, mortgage and asset-backed securities. The fund also includes some insurance and FDIC backed bonds.

Bonds are considered very low risk, especially if a fund includes federal backed securities. Bonds are usually not something I would look into because with the low risk, they are usually a very low returning investment, but these past few years due to the market fluctuations, bonds are returning very high. The short-term bond fund featured at my bank has a one year return of 9%, and a ten year of close to 5% average. The risk index given to this particular bond fund is between -1% and 12%.

The term short-term in a bond fund’s case means an under twelve month maturity, but the liquidity is somewhat unclear.

These options to house an emergency fund are less traditional but they offer higher returns with other potential benefits such as the tax advantages of a Roth IRA account. However, the risk is higher and virtually indeterminable because the market can go in any direction, at any moment.

Personally, I am leaning towards using my Roth IRA to house my emergency fund, but I am still back and forth between what type of investment to use within the Roth. If you have or currently use these options for your emergency fund, or investments in general, please let me know your thoughts on them.

Image by Mykl Roventine

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