Author Topic: Emergency Fund thoughts/question  (Read 7018 times)

Jags4186

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Emergency Fund thoughts/question
« on: August 05, 2015, 09:48:18 AM »
For numerous reasons I keep a $15,000 emergency fund sitting in a 1% online savings account.  The rest of my investments are 100% in VTSAX and equivalents.

I have been thinking how can I get better returns on this money and I've come up with this idea.

My 401k plan offers a stable value fund which offers a guaranteed 3% return.  If I were to put $15k of my 401k into this fund could I move my emergency fund into VTSAX in my taxable account avoid pretty much most risk and also increase my return by 2%.

Here's the thought process.  I already have 40k sitting in a taxable account.  If I were to move another 15k there that would be 55k in a taxable account.  If the stock market dived 62% tomorrow AND I needed to access my 15k, I would still have 15k in that account which I could liquidate.  Meanwhile, I would have 15k sitting in a stable value account in my 401k which I could then reinvest into my 401k VTSAX equivalent as I pulled money out of my taxable account.  As rebuild my taxable account, I would slowly move a portion of my 401k back to the stable value fund.

Can someone poke a hole in my plan?

BarkyardBQ

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Re: Emergency Fund thoughts/question
« Reply #1 on: August 05, 2015, 10:00:37 AM »
You are trying to gain 2% on cash by reallocating 15k in your 401k to a lower performing fund... dragging your 401k's performance. Then you are trying to make up for it in a taxable account, meanwhile being completely ok with pulling out your 15k from the taxable account if the stock market dives?

Don't drag down your 401k. Invest 15k into your Asset Allocation and carry on.

You seem to understand the risk, commit to it and leave the 401k alone.

If not stick the 15k into a tax managed fund in your taxable account and continue treating it like the black sheep of your portfolio.

We just invested half of our emergency fund into VTSAX in our taxable account, with the intention of investing the other half by year end. This is a compromise between my risk level and my wife's comfort level. Do what works for you, but only change your asset allocation if you are confident you want to do that forever.
« Last Edit: August 05, 2015, 10:02:28 AM by zdravé »

Retired To Win

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Re: Emergency Fund thoughts/question
« Reply #2 on: August 05, 2015, 10:01:23 AM »
If you need to pull money out of that taxable account for an emergency, there's the risk of having to liquidate holdings at a loss in order to get the cash.  If instead you're holding the cash in a savings account, you don't run that risk.  You could counterargue that the money in the savings account has an opportunity cost and inflation deterioration.  But the inflation cost is less than 1% per year net and the opportunity cost only applies (IMHO) on a longterm basis, because in the short term you cannot count on any particular market return rate.

My bottom line?  Emergency reserve funds are best kept in cash.  Any hypothetical loss of return from doing so is simply the cost of doing that business.

BarkyardBQ

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Re: Emergency Fund thoughts/question
« Reply #3 on: August 05, 2015, 10:04:11 AM »
@Retired To Win, don't you think it matters whether he's retired or in the accumulation phase?

Jags4186

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Re: Emergency Fund thoughts/question
« Reply #4 on: August 05, 2015, 10:08:44 AM »
If I look at my total assets as my complete portfolio, it shouldn't matter whether I have $15,000 cash sitting in a savings account, sitting in my 401k, or sitting under my mattress.  I don't look at the performance of my 401k separately from the performance of my taxable accounts.

If the stock market dives and I am forced to sell off my taxable portfolio at a loss, I am also reinvesting my 401k stable value fund into the identical fund at the now reduced price.  This mitigates the "selling at a loss" risk as I'll be buying the same number of shares that I am selling--but just now in my 401k.

The "risk" I am taking is that I am continually shifting my taxable account assets into tax deferred account assets...which I am not 100% sure if that is actually a risk or not just yet.
« Last Edit: August 05, 2015, 10:11:30 AM by Jags4186 »

Jags4186

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Re: Emergency Fund thoughts/question
« Reply #5 on: August 05, 2015, 10:15:13 AM »
We just invested half of our emergency fund into VTSAX in our taxable account, with the intention of investing the other half by year end. This is a compromise between my risk level and my wife's comfort level. Do what works for you, but only change your asset allocation if you are confident you want to do that forever.

Zdrave,

I don't believe by doing what I am describing I am actually changing my asset allocation.  I am only changing the location of the particular assets.

BarkyardBQ

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Re: Emergency Fund thoughts/question
« Reply #6 on: August 05, 2015, 10:39:41 AM »
If you aren't currently invested in the stable value fund aren't you changing your AA if you include it? I'd also evaluate your guaranteed return minus the expense ratio of the fund and custodial fees on the account.


I guess the point I'm trying to make is that if bonds aren't a part of my portfolio I'm not going to add bonds to get a better return on my cash. I'm going to assume the risk of being 100% equities and deal with the situation of needing cash from it in an emergency when that time comes. I think that assuming you will have to pull the cash from investments at a loss or holding bonds (or whatever) outside of your asset allocation is market timing as you are seeking a specified return and expecting the deviation to save you in the event of an emergency.

Are you retired or working?

I could also see an argument for investing the cash and in the event of an emergency you just reduce your 401k contributions if the market is down.

I hope you don't mind my questions, the emergency fund is something DW and I trying to optimize, strategies are being reviewed. BobW here on the forum has laid out a lot of arguments against cash holdings, and since we currently trying to figure out what to do with our emergency fund I keep trying to think of different ways to deal with possible situations where we would need extra cash but keeping all cash going to investments until that time.

Jags4186

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Re: Emergency Fund thoughts/question
« Reply #7 on: August 05, 2015, 10:58:06 AM »
If you aren't currently invested in the stable value fund aren't you changing your AA if you include it? I'd also evaluate your guaranteed return minus the expense ratio of the fund and custodial fees on the account.


I guess the point I'm trying to make is that if bonds aren't a part of my portfolio I'm not going to add bonds to get a better return on my cash. I'm going to assume the risk of being 100% equities and deal with the situation of needing cash from it in an emergency when that time comes. I think that assuming you will have to pull the cash from investments at a loss or holding bonds (or whatever) outside of your asset allocation is market timing as you are seeking a specified return and expecting the deviation to save you in the event of an emergency.

Are you retired or working?

I could also see an argument for investing the cash and in the event of an emergency you just reduce your 401k contributions if the market is down.

I hope you don't mind my questions, the emergency fund is something DW and I trying to optimize, strategies are being reviewed. BobW here on the forum has laid out a lot of arguments against cash holdings, and since we currently trying to figure out what to do with our emergency fund I keep trying to think of different ways to deal with possible situations where we would need extra cash but keeping all cash going to investments until that time.

I already have $15,000 in cash making .99% interest at Ally.  I would be investing this $15,000 and then taking on the stable value fund.  As far as I am aware the stable value fund is basically a cash equivalent account that makes a better return.

NotJen

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Re: Emergency Fund thoughts/question
« Reply #8 on: August 05, 2015, 11:09:27 AM »
I did exactly this at the end of last year. I have $15k in my 401k's stable value fund to "make up" for the $15k I started my taxable account with. It's temporary - as soon as my taxable account is hefty enough, I'll consider it my EF and reinvest the stable value $ into the target date fund I use there.

(My total EF is $30k, so I kept $15k in my 1% savings account.)

No, it doesn't change your AA.

Eric

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Re: Emergency Fund thoughts/question
« Reply #9 on: August 05, 2015, 11:33:27 AM »
Sounds like a good plan to me Jags.

AZDude

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Re: Emergency Fund thoughts/question
« Reply #10 on: August 05, 2015, 12:47:31 PM »
There is no equivalent of the stable value fund outside of your 401(k)? If you put any money into a low performing fund, you would want it to happen in your taxable account, not the 401(k).

Eric

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Re: Emergency Fund thoughts/question
« Reply #11 on: August 05, 2015, 01:08:19 PM »
There is no equivalent of the stable value fund outside of your 401(k)? If you put any money into a low performing fund, you would want it to happen in your taxable account, not the 401(k).

What's the difference?  Your Asset Allocation is spread across all your accounts.  Where you hold the value fund (or any fund) has no effect.

If you want to tap the value fund from your 401k, then you just adjust your non-401k assets accordingly.

BarkyardBQ

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Re: Emergency Fund thoughts/question
« Reply #12 on: August 05, 2015, 01:14:45 PM »
There is no equivalent of the stable value fund outside of your 401(k)? If you put any money into a low performing fund, you would want it to happen in your taxable account, not the 401(k).

What's the difference?  Your Asset Allocation is spread across all your accounts.  Where you hold the value fund (or any fund) has no effect.

If you want to tap the value fund from your 401k, then you just adjust your non-401k assets accordingly.

Taxes.

If you're going to hold a lower performing, lower dividend, lower capital gains fund it should be in the place where you will pay the least amount of taxes on it.

zephyr911

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Re: Emergency Fund thoughts/question
« Reply #13 on: August 05, 2015, 01:47:19 PM »
My credit card is my EF. $26K limit and always paid off unless parking investment debt on a 0% promotion. Depending where the charge falls in the month, 30-60 days to pay off using new income, liquidate something else, or transfer to a lower APR while killing it off. Most promo balance transfers equate to 3% APR or less.

If your investments are making what they should, and your credit is good, this beats cash reserves all the time. See also: HELOC.

Eric

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Re: Emergency Fund thoughts/question
« Reply #14 on: August 05, 2015, 02:02:49 PM »
There is no equivalent of the stable value fund outside of your 401(k)? If you put any money into a low performing fund, you would want it to happen in your taxable account, not the 401(k).

What's the difference?  Your Asset Allocation is spread across all your accounts.  Where you hold the value fund (or any fund) has no effect.

If you want to tap the value fund from your 401k, then you just adjust your non-401k assets accordingly.

Taxes.

If you're going to hold a lower performing, lower dividend, lower capital gains fund it should be in the place where you will pay the least amount of taxes on it.

Like in a 401k?

BarkyardBQ

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Re: Emergency Fund thoughts/question
« Reply #15 on: August 05, 2015, 02:21:53 PM »
There is no equivalent of the stable value fund outside of your 401(k)? If you put any money into a low performing fund, you would want it to happen in your taxable account, not the 401(k).

What's the difference?  Your Asset Allocation is spread across all your accounts.  Where you hold the value fund (or any fund) has no effect.

If you want to tap the value fund from your 401k, then you just adjust your non-401k assets accordingly.

Taxes.

If you're going to hold a lower performing, lower dividend, lower capital gains fund it should be in the place where you will pay the least amount of taxes on it.

Like in a 401k?


You pay no taxes in a 401k. You pay taxes on a taxable account.

If you put something in taxable that performs at 7% you will pay more taxes than if you put something in there that only gains 3%. Therefore anything that returns more income/dividends or capital gains vs something else in your allocation should go where it will be protected from taxes.

http://www.bogleheads.org/wiki/Principles_of_tax-efficient_fund_placement

Jags4186

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Re: Emergency Fund thoughts/question
« Reply #16 on: August 05, 2015, 02:33:05 PM »
zdrave,

I understand your comment on taxes.  But look at it this way:  would you rather pay taxes on earnings (selling appreciated assets in a taxable account) or pay no taxes because there are no earnings (drawing money out of a savings account).

I'd rather pay taxes on having made money than not pay taxes and not have made any money.

On the other side of things, if I sold my taxable investments at a loss I would be able to tax loss harvest.

Eric

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Re: Emergency Fund thoughts/question
« Reply #17 on: August 05, 2015, 02:38:08 PM »
There is no equivalent of the stable value fund outside of your 401(k)? If you put any money into a low performing fund, you would want it to happen in your taxable account, not the 401(k).

What's the difference?  Your Asset Allocation is spread across all your accounts.  Where you hold the value fund (or any fund) has no effect.

If you want to tap the value fund from your 401k, then you just adjust your non-401k assets accordingly.

Taxes.

If you're going to hold a lower performing, lower dividend, lower capital gains fund it should be in the place where you will pay the least amount of taxes on it.

Like in a 401k?


You pay no taxes in a 401k. You pay taxes on a taxable account.

If you put something in taxable that performs at 7% you will pay more taxes than if you put something in there that only gains 3%. Therefore anything that returns more income/dividends or capital gains vs something else in your allocation should go where it will be protected from taxes.

http://www.bogleheads.org/wiki/Principles_of_tax-efficient_fund_placement

Yeah, I know how it works.  Your statement (bolded) was that you should place the fixed income fund where you would pay the least amount of taxes.  The least amount of taxes, would be $0 in the 401k.  With me?  So you seem to be saying that it should be held simultaneously in the 401k and also not in the 401k.


@Jags4186 -- Is this fund not available outside of the 401k?

Jags4186

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Re: Emergency Fund thoughts/question
« Reply #18 on: August 05, 2015, 02:41:40 PM »
There is no equivalent of the stable value fund outside of your 401(k)? If you put any money into a low performing fund, you would want it to happen in your taxable account, not the 401(k).

Yes if I wanted to open a lake michigan credit union account and jump through those hoops (multiple login's a month, multiple debit transactions). I don't.

Yes if I want to mess around with multiple Mango accounts. I don't.

Right now I have the money sitting in Ally bank at .99% interest.

By moving the money I would take it out of a 401k fund that I'm paying a .58% ER on (best available) and into a Vanguard fund I'm paying .05% on.  So the full swing would be a 2.54%/yr gain on 15k by making this move.

BarkyardBQ

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Re: Emergency Fund thoughts/question
« Reply #19 on: August 05, 2015, 02:45:30 PM »
zdrave,

I understand your comment on taxes.  But look at it this way:  would you rather pay taxes on earnings (selling appreciated assets in a taxable account) or pay no taxes because there are no earnings (drawing money out of a savings account).

I'd rather pay taxes on having made money than not pay taxes and not have made any money.

On the other side of things, if I sold my taxable investments at a loss I would be able to tax loss harvest.

Jags,

You want to hold Emergency Stable Fund in a 401k so you can sell in your taxable account and recover it in your 401k...

You're making a lot more work for yourself. Counting on this strategy is simplified by holding the Stable Fund in your taxable account, and sell it if you have an emergency, and not having to worry about selling VTSAX at a loss if you do.

Eric,

You have 2 funds, 1 produces minimal growth and minimal dividends, the other produces higher growth and larger dividends.

Fund 1 in a taxable account, will increase your income tax by very little.
Fund 2 in a taxable account, will increase your income tax by much more.

Either one in a 401k will not effect your taxes.

You place the fund that will produce the most income and growth in tax advantaged accounts first (so you pay 0 taxes), while placing lower growth  lower income funds in your taxable account (so you pay less taxes).

Jags4186

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Re: Emergency Fund thoughts/question
« Reply #20 on: August 05, 2015, 02:46:15 PM »
Yeah, I know how it works.  Your statement (bolded) was that you should place the fixed income fund where you would pay the least amount of taxes.  The least amount of taxes, would be $0 in the 401k.  With me?  So you seem to be saying that it should be held simultaneously in the 401k and also not in the 401k.


@Jags4186 -- Is this fund not available outside of the 401k?

I am unable to find any publicly available stable value/money market account that offers 3%.  If you know one, please let me know!

Eric

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Re: Emergency Fund thoughts/question
« Reply #21 on: August 05, 2015, 03:00:34 PM »
Eric,

You have 2 funds, 1 produces minimal growth and minimal dividends, the other produces higher growth and larger dividends.

Fund 1 in a taxable account, will increase your income tax by very little.
Fund 2 in a taxable account, will increase your income tax by much more.

Either one in a 401k will not effect your taxes.

You place the fund that will produce the most income and growth in tax advantaged accounts first (so you pay 0 taxes), while placing lower growth  lower income funds in your taxable account (so you pay less taxes).

Again, I know how it works.  I'm merely pointing out your contradictory statements.

If you're going to hold a lower performing, lower dividend, lower capital gains fund it should be in the place where you will pay the least amount of taxes on it.
You place the fund that will produce the most income and growth in tax advantaged accounts first (so you pay 0 taxes), while placing lower growth  lower income funds in your taxable account (so you pay less taxes).

As I mentioned above, you seem to be simultaneously recommending the fund for the 401k and also not for the 401k, considering the 401k is where "you will pay the least amount of taxes."
« Last Edit: August 05, 2015, 03:12:33 PM by Eric »

Jags4186

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Re: Emergency Fund thoughts/question
« Reply #22 on: August 05, 2015, 03:09:50 PM »

Jags,

You want to hold Emergency Stable Fund in a 401k so you can sell in your taxable account and recover it in your 401k...

You're making a lot more work for yourself. Counting on this strategy is simplified by holding the Stable Fund in your taxable account, and sell it if you have an emergency, and not having to worry about selling VTSAX at a loss if you do.

It is no work at all other than initiating 1 sell order and 1 buy order in the event I actually need the money.

Eric,

You have 2 funds, 1 produces minimal growth and minimal dividends, the other produces higher growth and larger dividends.

Fund 1 in a taxable account, will increase your income tax by very little.
Fund 2 in a taxable account, will increase your income tax by much more.

Either one in a 401k will not effect your taxes.

You place the fund that will produce the most income and growth in tax advantaged accounts first (so you pay 0 taxes), while placing lower growth  lower income funds in your taxable account (so you pay less taxes).

You seem to be missing the opportunity cost. The opportunity cost of keeping keeping cash in a taxable account making .99% is the 2% or so growth I am losing by not keeping it in the 401k.  If I am forced to sell the investment at a gain, the opportunity cost is paying taxes on a gain I would not have had in the first place.

Example A)
$15000 making 1% in regular savings account, end year 1 have $15150.
Pay taxes on $150 ($40), net $15110 after year 1.

$15000 in 401k makes 10% and is worth $16500 after year 1.

Total amount held after year 1)  $31610.00

Emergency! Need 15k either all at once or over time, total account value falls to $16610.00

Example B)
$15000 invested in taxable account mutual fund making 10%, end year 1 have $16500

$15000 in 401k makes 3% and is worth $15450 after year 1.

Total amount held after year 1) $31950

Emergency! Need 15k either all at once or in a lump.


Sell $15000 of taxable investment.  Pay LTCG on $1500:  $225
Buy $15450 in 401k.

Left with:   
$1275 taxable account
$15450 in 401k
Total account value: $16725


Jags4186

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Re: Emergency Fund thoughts/question
« Reply #23 on: August 05, 2015, 03:14:25 PM »
Now I don't know whether I would actually do this for a marginal gain (especially since interest rates and therefore regular ole' savings accounts rates have only 1 way to go), but for people who have a large cash position OR people who believe that interest rates are going to stay low for the foreseeable future, this might be worth considering.

BarkyardBQ

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Re: Emergency Fund thoughts/question
« Reply #24 on: August 05, 2015, 03:29:31 PM »
I never suggested you don't invest the 15k. I'm suggesting you invest it into a taxable account into the stable fund.

Eric. tsk tsk

MoonShadow

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Re: Emergency Fund thoughts/question
« Reply #25 on: August 05, 2015, 03:43:15 PM »
Money is fungible, but only in a level tax regime.  We don't have that in this scenario.

Here's one idea to consider.  Because taxes are always a concern, and you do want your e-fund invested, consider your many accounts as a total portfolio; but distribute the assests according to their taxable gains potential.

Said another way, your most aggressive assets would be best in your Roth IRA or HSA.

Your large cap/conservative stocks and/or mutual funds would be best in your 401k

Your tax advantaged and low voltility investments should be in your taxable account; such as municipal bond funds, or tax-managed funds.  Your e-fund should be in the taxable account, invested in something with a decent track record; but still fairly liquid in the event of a need for it.  A balanced/diversified fund, a target fund, or simply a bond fund; would all be good choices.  A REIT might also be a fine choice, if the cash out rules were not onerous.

In this way; the portion of your total portfolio with the greatest potential gains over the long term will forever be protected from taxation within you Roth and/or HSA.  The bulk of your savings will likely turn an okay dividend within your 401k, but you benefited from the tax deduction in the near term.  And your taxable account, the one that is most readily accessible in the event of a crisis, forms the diversification portion of your portfolio protecting you from a major downturn; but is unlikely to result in particularly large taxable gains if the market goes on a tear.

AZDude

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Re: Emergency Fund thoughts/question
« Reply #26 on: August 05, 2015, 04:02:55 PM »
There is no equivalent of the stable value fund outside of your 401(k)? If you put any money into a low performing fund, you would want it to happen in your taxable account, not the 401(k).

What's the difference?  Your Asset Allocation is spread across all your accounts.  Where you hold the value fund (or any fund) has no effect.

If you want to tap the value fund from your 401k, then you just adjust your non-401k assets accordingly.

The 401(k) grows tax free, where the taxable does not. So if you have a low-growth fund, you want it in the taxable account. This is painfully simple to understand, what is the problem?

Eric

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Re: Emergency Fund thoughts/question
« Reply #27 on: August 05, 2015, 04:08:32 PM »
There is no equivalent of the stable value fund outside of your 401(k)? If you put any money into a low performing fund, you would want it to happen in your taxable account, not the 401(k).

What's the difference?  Your Asset Allocation is spread across all your accounts.  Where you hold the value fund (or any fund) has no effect.

If you want to tap the value fund from your 401k, then you just adjust your non-401k assets accordingly.

The 401(k) grows tax free, where the taxable does not. So if you have a low-growth fund, you want it in the taxable account. This is painfully simple to understand, what is the problem?

I believe the main problem is that the fund is not available outside of the 401k.  Otherwise, it would make perfect sense to just invest in it in a taxable account.

AZDude

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Re: Emergency Fund thoughts/question
« Reply #28 on: August 05, 2015, 04:09:56 PM »
There are a multitude of funds and ETFs out there, surely one can duplicate well enough what is offered in a 401(k).

Eric

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Re: Emergency Fund thoughts/question
« Reply #29 on: August 05, 2015, 04:46:09 PM »
I am unable to find any publicly available stable value/money market account that offers 3%.  If you know one, please let me know!

There are a multitude of funds and ETFs out there, surely one can duplicate well enough what is offered in a 401(k).

Then help him out!  What fund would you recommend?

AZDude

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Re: Emergency Fund thoughts/question
« Reply #30 on: August 05, 2015, 05:06:40 PM »
You could do something like VBMFX, Vanguard Total Bond Market Index. It has averaged a little over 3% for the last five years and has a, relatively, low expense ratio - 0.2%. Looking at the historical price, it has stayed relatively consistent. I would say its good for what it is, a low risk, low reward place to stash some cash.

MoonShadow

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Re: Emergency Fund thoughts/question
« Reply #31 on: August 05, 2015, 05:10:24 PM »
I am unable to find any publicly available stable value/money market account that offers 3%.  If you know one, please let me know!

There are a multitude of funds and ETFs out there, surely one can duplicate well enough what is offered in a 401(k).

Then help him out!  What fund would you recommend?
Stable rate funds are an artifact of 401k's, and are basicly a combo of a long term bond fund with an insurance/hedge contract to protect against short term losses.

https://en.wikipedia.org/wiki/Stable_value_fund

"Regardless of how stable value funds are structured, they are a diversified portfolio of fixed income securities that are insulated from interest rate movements by contracts from banks and insurance companies. How this contract protection is delivered depends on the type of stable value fund investment purchased and is provided through one or more of the following investment instruments"

But note that they are not risk free.  I can't find any on the open market, and suspect that they only exist inside government regulated retirement accounts.