You finally did it. You saved the default emergency fund amount of 3-6 month’s of expenses, and can have some peace of mind if you lose your job. Emergency funds are not just for peace of mind either, they can also be an asset that can make you money. Profiting off your emergency fund can be tricky, because you want to make as much money as possible, but don’t want the money to be gone when you need it. Where can you put your emergency fund money that satisfies these requirements?
The problem with cash
What’s wrong with keeping the emergency fund savings in cash? Cash easy to access and safe. The big problem is cash depreciates. Every year we have 1-3% inflation and your pile of cash can buy less and less, until in the end it’s worth a fraction of what it used to be. For example if you saved $30,000 for an emergency fund and there was 3% inflation each year you would end up losing $7,194 of buying power after 10 years.
High yield savings account
Most banks give very poor levels of return on savings. You can better protect your cash from inflation with a high yield savings account. If you love your low APY bank, you can keep it and just use the high yield savings account for your emergency fund alone.
Five higher yield savings accounts
Live Oak Bank – %60 APY
Vio Bank – %57 APY
Quontic Bank – %55 APY
Ally Bank – %50 APY
Marcus by Goldman Sachs – %50 APY
There is an additional type of high yield checking account where they will give you even higher returns if you do things like use the bank’s debit card. I don’t really recommend these, because a debit card does not protect you against fraudulent purchases like a credit card does, and you do not earn rewards at the same level as a credit card.
Five higher yield checking accounts
La Capitol Federal Credit Union – 4.25% APY on balances up to $3,000. 2.00% APY on balances up to $10,000
Consumers Credit Union – 4.09% APY on balances up to $10,000
Evansville Teachers Federal Credit Union – 3.30% APY on balances up to $20,000
Market USA Federal Credit Union – 3.01% APY on balances up to $15,000
Lake Michigan Credit Union – 3.00% APY on balances up to $15,000
When a corporation or a government needs money they issue bonds. When you buy a bond the issuer of the bond is making a promise to pay you back with interest. Bonds can be a very safe way to invest when they are issued by the government or a reputable corporation, and they can pay out more than a savings account. There are less safe bonds, oftentimes referred to as junk bonds, where the risk of losing your money is much higher, but the potential interest rate is higher as well. You can buy bonds directly, and you can also invest in them with ETFs.
To give you an idea of what your returns might have looked like, here are some examples. Had you invested in TLT, the 20-year treasure bond ETF, from 2008 you would have had a 5.93% annual return with a max drawdown of 21.8%. If you had invested in BND, which is a corporate bond ETF, you would have had a 3.78% annual return with a 4.01% max drawdown.
Recently interest rates have been close to zero. This means that bonds have not been paying as well as they have in the past and there is a risk that you will not get as good of a return on your money if inflation rises.
There are a few ways you can help mitigate the inflation risk:
- Invest in inflation linked government bonds. These bonds are referred to as TIPS bonds and the rate of return will rise with inflation. What’s the catch? They are based on the Consumer Price Index and some people feel that it does not adequately show the rate of inflation. The TIP ETF can give you exposure to this bond type.
- Invest in bonds from other countries. China for example still has high interest rates and the bond yields are higher than the US government. CBON is an ETF that gives you exposure to the Chinese bond market.
- Invest in emerging market bonds. These bonds tend to do worse when the dollar gets stronger, but in time of inflation they can pay off and have good rates of returns. The EMB ETF can give you exposure to emerging bonds.
Putting your emergency fund in the stock market sounds like the worst thing you could possibly do. The stock market could crash, and you could potentially lose a large portion of your emergency fund. Typically, when the market is crashing the economy is crashing too, and you may lose your job at the exact moment you need your emergency fund the most.
The benefit of the stock market is that it has typically had one of the higher returns on investment. If you had invested your $30,000 emergency fund in the VTI ETF, which represents the total stock market, since 2002 you would have received an average 9.37% return on your money each year, and you would have $168,359 in your emergency fund.
Is it as crazy as it sounds? Is there a way to get these lucrative profits, without being denied your emergency fund when you need it the most?
Big stock market draw downs typically happen every 10 years or so. This means it’s pretty unlikely that you would encounter one for a while and your account would grow to help take some sting out of a downturn. For this exercise, we should prepare for the worst, which would be a drawdown immediately after you invest. Based on past performance the worst draw downs of the stock market have been about 50%.
The first thing you could do to mitigate the issue would be to double the amount that you save for your emergency fund. It’s not dead money, that money will be creating wealth for you, so it’s not a bad idea in that sense.
Another thing you could do is what is called an all weather portfolio. This combines three or more assets that are not correlated, but have an upwards trajectory. For example, the All Weather Portfolio was created by Ray Dalio, who runs the largest and highest earning hedge fund of all time. It consists of bonds, commodities and stocks. Each part of the portfolio goes up, but they go up at different times and that helps limit the downside. To give you an idea of how it works in practice, during the March 2020 crash, the stock market was down 30% and the All Weather Portfolio was only down 4%. That’s a lot less stress! Had you invested in the All Weather Portfolio 2007 it would have given an average return of 7.56% annual return, so you make less than the stock market, but don’t have to deal with the large fluctuations of equities.
Some other examples of all weather portfolios:
The Permeant Portfolio by Harry Browne – This is a combination of stocks, bonds, gold and cash. During the March 2020 crash it only fell 5%. Had you invested in 2007 it would have given an average 6.79% annual return.
The Golden Butterfly Portfolio – This is a mix of gold, bonds and equities and has returns 7.57% since 2008.
Risk Parity ETF (RPAR) – RPAR was created by a former employee at Bridgewater, Ray Dalio’s company. It’s an all weather ETF. With these other all weather portfolios you need to create them with ETFs and rebalance them, this one simplifies the process by allowing you to buy just a single ETF and forget about it. RPAR has not been around for a long time, but it has made 11.08% since it started in 2020. The downside here is there is not a lot of data to prove out that it will stand the test of time for large market crashes.
If you go the stock route, one option to consider is a Roth IRA. If you use a Roth IRA you will not get charged capital gains on your stock sales and dividends, until you take out the money. The money is stuck in there, but you can withdraw it without a penalty if you are having a financial hardship, which is typically what you would use an emergency fund for.
Using this investment growth calculator you can get the idea of the extra money you would have in your account if you started with $6000 after 10 years.
Emergency fund in a Roth IRA end value $11,215
Emergency fund in a taxable account end value $10,745
Crypto banks store crypto then loan it out for a profit and pass some money on to the person who is storing crypto at their location. For example if you deposit your Bitcoin into Nexo they will pay you 6% annually to hold it. Bitcoin is a bit more of a speculative investment for an emergency fund and the volatility is more than people could typically stomach. An alternative you can do to Bitcoin are stable coins. In particular if you buy USD Coin it is backed by dollars and its value does not fluctuate, it’s always worth $1. The interest rates on USD Coin you can get can be upwards of 10%. There are 3 big players in this space right now:
BlockFi – 8.6% interest on USD Coin.
Nexo – 10% on USC Coin.
Celsius – 10.51% on USC Coin. Use referral code 102635c86a to get $40 in BTC.
Sound good? You can make more money than the stock market here without any dips. Is this the perfect emergency fund investment or is there a catch? Unfortunately there is always a catch. These companies are new and trying to get customers, and it’s not likely that the interest rates will stay this high forever. The other danger is that these companies can go out of business, which would result in a 100% loss of an investment. In my opinion the one that is least likely to go out of business would be BlockFi, because it has the backing of a billionaire. I personally do have some level of confidence that they are going to be around for a while and have my money invested in Celsius. I picked Celsius due to it having the highest rate of return. I would not recommend putting 100% of the emergency fund in these, because then you really could be left with no money in an emergency.
In case you are wondering, I do use these techniques. My Emergency Fund is over funded by 25%. Here is my investment breakdown:
- 20% in a high yield savings account.
- 60% in an all weather fund.
- 20% in a crypto bank.
I hope you found this helpful. An emergency fund is a great thing to have. It can bail you out when you run into trouble, it can make you more bold when taking financial risks, and it can also make you a lot of money too!