Author Topic: Emergency Fund Allocation  (Read 1402 times)

Jevs05

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Emergency Fund Allocation
« on: September 14, 2017, 10:15:20 AM »
Hi there!

I have built up a savings account with enough money to complete what I want to call my emergency fund, but can't decide where to put it. I have been looking at investing it in essentially what would be a retirement account (40% stock 60% bond) with vanguard to help lower fees, grow it a little bit as opposed to having it sit in a bank, and still have access to it. Is this a terrible idea or a good one? I know Betterment has a similar set up, but I could buy into a Vanguard fund with lower fees to do essentially the same idea. Thoughts?

Nederstash

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Re: Emergency Fund Allocation
« Reply #1 on: September 17, 2017, 11:20:52 AM »
Hi! I believe an emergency fund of 3-6 months of expenses needs to be quickly accessible, so I wouldn't invest it! Sure, you won't make money on it, but it's there to protect the money that is going to make you money. Look at it as insurance against Murphy's Law. If you have a stable income, a partner with an income and/or sizable other investments, you can keep your EF to 3 months' expenses.

Acastus

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Re: Emergency Fund Allocation
« Reply #2 on: September 18, 2017, 11:11:23 AM »
Most finance folk, and me, recommend keeping emergency funds in cash. That means checking, savings, money market, 3 to 6 month T-bills. I also earmark my short term bond fund (1-3 year maturity) as longer term emergency, knowing it is slightly risky. If you need the money in an emergency, the last thing you want is for 30% to be missing because stocks did badly.

Jevs05

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Re: Emergency Fund Allocation
« Reply #3 on: September 18, 2017, 11:52:20 AM »
So if it put my money into a taxable money market account, that would be a good idea? With putting it into a money market account, what type of funds would you reccomend, or would you just have it sit there in the money market account?

Thanks so much!

Lady SA

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Re: Emergency Fund Allocation
« Reply #4 on: September 18, 2017, 12:09:12 PM »
I just have our emergency fund in a bank savings account. I'm at a credit union and have a high interest savings account so I still get 2% interest on my balance. I would suggest Ally or a local credit union and not a money market account, as it is easy to transfer money back and forth between savings and checking accounts when you need it.

Laura33

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Re: Emergency Fund Allocation
« Reply #5 on: September 18, 2017, 01:37:15 PM »
So if it put my money into a taxable money market account, that would be a good idea? With putting it into a money market account, what type of funds would you reccomend, or would you just have it sit there in the money market account?

Thanks so much!

There are two different things that I think are getting mixed up here:  the bucket in which you hold the investments; and the investments themselves.

When you ask whether you should have something in a retirement account or a taxable account, you are talking about the bucket.  For an emergency fund that needs to be accessible quickly, you want to use either a taxable account or a Roth (because you can take your contributions out of a Roth if you need them down the road without triggering taxes/penalties).  You do not want to use a 401(k) or a traditional IRA for this account, because taking out the money would be considered an early distribution and would trigger taxes and penalties from the IRS.

When you talk about money markets and funds and the like, you are talking about the investments themselves -- what you are buying with your deposits.*  This can be stocks, bonds, money market funds, index funds, REITs, or any number of other things.  For an emergency fund, you want something that you know will be there when you need it, like a savings account, a money market account, or short-term CDs.  You do not want to put your EF into any kind of stock or bond investment, because those will go up and down with the market (sometimes dramatically), which means that you can't guarantee that your EF will be worth what you invested when you actually need the money.**   

Personally, I am not a fan of using a Roth as the EF.  You can put only @$5500/yr into a Roth, and you want to be able to use that tax-protected space for your retirement; since retirement is a long-term goal, you want that money in the market (stocks/bonds/funds), which is your best chance for the long-term growth you need.  But per the above, an EF needs to be available to cover very short-term needs and so should not be invested in the market.  So you'd be using up your limited opportunity to let your retirement investments grow tax-free for decades for an EF in a money market that is not going to grow to provide what you need to retire, and that you may in fact withdraw next month!***  This makes no sense to me. 

The only way I could see this making sense is as a short-term measure, when you're just getting started and don't have enough cash to fully fund both a Roth AND an EF -- then you might as well use the $5500/yr you are entitled to for the Roth as your EF for the short-term (since otherwise you'd just forfeit the Roth for that year entirely -- just make sure to invest that $ in a money market).  Then, once your EF is at a reasonable amount, you'd start to put your future years' Roth investments into the market (e.g., the Vanguard fund you mentioned).  And if at some point you were able to invest more than the $5500/yr, you could build up a "real" EF in a taxable account, and then transfer those original Roth contributions into a Vanguard fund as well.****

* So asking what kinds of investments you should choose in your money market doesn't make any sense, since a money market IS a type of investment (it's just an investment in more stable assets, i.e., commercial paper products that can be liquidated quickly).

** And unfortunately, usually the kinds of things that cause you to lose your job and need your EF are also the kinds of big economic events that cause the stock market to crash. 

*** And once you withdraw contributions from your Roth, you can't put them back -- it's not a loan.

**** Note that you can change the investments within a Roth at any time -- so if you start with a $5500 emergency fund in a money market, and then two years later you have built a regular emergency fund in a different taxable account, you can sell the money market funds inside your Roth and buy a Vanguard stock fund with those proceeds, all inside that same Roth "bucket."