Tax Exempt Bond Fund as Emergency Fund?

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DireWolf
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Joined: Mon May 04, 2009 4:53 pm

Tax Exempt Bond Fund as Emergency Fund?

Post by DireWolf »

I alluded to this question in the fixed income thread.

I currently keep my emergency fund (1 year of expenses) in Vanguard's tax exempt money market fund in my taxable account.

It would certainly be nice to improve yield (currently 0%). Would a tax exempt bond fund be a good way to improve yield and still offer the flexibility I need in an emergency fund?

My emergency fund serves 2 purposes... provide cash in an emergency and purchase equities in a down market.

As I understand the dividends paid by the fund are exempt from federal taxes but not state taxes (Missouri capital gains and income tax rates are 6%)

But if I sell a portion of the fund for an emergency or to buy equities, I would pay state capital gains taxes (6%) but no federal taxes.

Do I understand these principles correctly?


The next issue would be... should I use a short-term, limited-term, intermediate term, or long-term tax exempt fund? Retirement is 20-30 years away, but the purpose of this fund is primarily for an emergency fund.
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cheese_breath
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Re: Tax Exempt Bond Fund as Emergency Fund?

Post by cheese_breath »

You realize bond funds lose value if interest rates increase? Then you will no longer have one year's worth of expenses in your emergency fund.

Instead of money market, have you considered putting the EF in a FDIC insured online bank earning close to 1% and just pay taxes on the earnings?

Do you really need one year's expenses in your emergency fund?
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fundtalk
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Re: Tax Exempt Bond Fund as Emergency Fund?

Post by fundtalk »

I use VWSUX, the short term tax exempt fund, as an emergency fund. It does fluctuate, but not very much. I would prefer to have it in the TE money market, but not at current rates. I'm willing to accept the extra rate risk since I have a very stable job and therefore have a low risk of needing to tap my emergency fund.
poker27
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Re: Tax Exempt Bond Fund as Emergency Fund?

Post by poker27 »

I have a tax exempt fund in my taxable account, but it would be the third funding 'group' I would tap (online savings first, and I bonds second). Your EF shouldn't be used to rebalance into equities. Put your EF into something that can't lose money, and then buy bonds for safety and balancing purposes
Topic Author
DireWolf
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Re: Tax Exempt Bond Fund as Emergency Fund?

Post by DireWolf »

I'm leaning towards the intermediate term tax exempt bond fund. Or maybe I'll just convert my emergency fund into I-Bonds. I much prefer to have all my taxable investments in one account at Vanguard, but there might be value in expanding outside the comfort zone.
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baw703916
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Re: Tax Exempt Bond Fund as Emergency Fund?

Post by baw703916 »

I'm not sure I like the I-Bonds idea. The reason I-Bonds are nice is that they're tax-deferred, so you can decide when to cash them in and pay taxes on the interest. But if they're your emergency fund and stuff happens, you are forced to cash them in and incur a tax bill at what may be an inopportune time.

Yes, you can lose money on any bond fund of finite duration. But realistically, how much has something like Limited Term Tax-Exempt ever gone down?

https://personal.vanguard.com/us/funds/ ... INT#tab=1a

(Since its inception in 2001, it has never dropped in value over the course of a calendar year. There's always a first time, but still...)

Intermediate-Term has a significantly higher possibility of dropping in value. That may be a bit too much in duration for an emergency fund. So that's why I mentioned Limited Term.
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am
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Re: Tax Exempt Bond Fund as Emergency Fund?

Post by am »

Tier your emergency fund. I use checking account--> FDIC savings account and CDs--> int muni TE. The int muni serves as a 3rd tier EM fund but also part of my allocation for new investment money every month. Think it would be a long shot to run through first two tiers. So I take a little risk for the last tier. Sometimes I am tempted to shift more money into inter muni but usually hold off for now.
digit8
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Re: Tax Exempt Bond Fund as Emergency Fund?

Post by digit8 »

Plus one on the tiered concept, though I go NCUA savings->Ibonds->taxable equity funds. I've thought about adding in a bond fund,but for some reason I always focus on the negatives- less safe then the savings, less return then then equity.
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ab80
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Re: Tax Exempt Bond Fund as Emergency Fund?

Post by ab80 »

You should use safer stuff for EFs. But depending on the fund, there may not be much fluctuation with the NAV. For instance, in the limited term fund, there's only been about a 10.6% increase in the price since 1992, but over a 600% increase in value if reinvesting dividends.

Baw: you don't mind the risk of losing money in your EF due to cashing out at an inopportune time, but you're worried about paying taxes on I Bonds at an inopportune time? If anything (especially with tiering), I'd expect taxes to be lower if you were unemployed and needed to cash out your EF.
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