A Low-Cost Diversified Emergency Fund Strategy

[statefan03]

Hello Bogleheads, First time starting a topic and I'd like your feedback.

I'm planning to move our 1-year expenses Emergency Fund from a Marcus online savings account to a new brokerage account at Fidelity. I have seen a lot of recommendations about using FIKFX (Fidelity Freedom Index Income Fund) for such a scenario, as the ~20% stock allocation provide some growth, while the Bonds, Tips, and ST Treasuries provide stability and some dividends.

I'm thinking if I purchase the individual funds myself instead of the FIKFX fund, I can:
1. Have lower expense ratios.
2. Have lower tax costs using more efficient ETFs.
3. Be able to TLH the individual funds at the end of the year even if the total portfolio is up.


Looking at the Backtest results it looks like I can match the results using tax efficient ETFs, and easily do better than money market returns.

So my question for you guys is, has anyone done anything similar and have any feedback? I'm thinking the possible drawbacks here are:

1. Trying to maintain my asset allocations over time.
2. If an emergency does happen and I need the money, I'll have to make multiple sell orders.

[am]

These are all assets that fluctuate in value. Maybe have 25% more than you need in case you need the money and the markets are all depressed.

[Lastrun]

I think this is an approach that I have seen advocated here. If I were young, in this rate environment, I would likely do the same. AM's thought of over funding is a good one and there was a recent thread on this approach viewtopic.php?t=309472

Also, time helps.

An investor who put there emergency fund into Vanguard's version of this fund during the peak and low of the 2008-09 GFC, went from $10K to 8.8K, and during the most recent downturn went from $10K to $9.2 K, so over funding at first will help mitigate this risk. Over time, this problem will diminish.

[aristotelian]

Sounds like you are trying to chase yield. I would keep the money where it is. You could accomplish the same effect by reducing your EF by 20% and investing the cash. Up to you if you want to do that but as far as safe yield goes, HYSA is the best.

[Robert20]

Hello Bogleheads, First time starting a topic and I'd like your feedback.

I'm planning to move our 1-year expenses Emergency Fund from a Marcus online savings account to a new brokerage account at Fidelity. I have seen a lot of recommendations about using FIKFX (Fidelity Freedom Index Income Fund) for such a scenario, as the ~20% stock allocation provide some growth, while the Bonds, Tips, and ST Treasuries provide stability and some dividends.

I'm thinking if I purchase the individual funds myself instead of the FIKFX fund, I can:
1. Have lower expense ratios.
2. Have lower tax costs using more efficient ETFs.
3. Be able to TLH the individual funds at the end of the year even if the total portfolio is up.


Looking at the Backtest results it looks like I can match the results using tax efficient ETFs, and easily do better than money market returns.

So my question for you guys is, has anyone done anything similar and have any feedback? I'm thinking the possible drawbacks here are:

1. Trying to maintain my asset allocations over time.
2. If an emergency does happen and I need the money, I'll have to make multiple sell orders.

If you have emergency fund need of 50K (as an example), def you dont need all 50K in one day.. So def laddering 50K in different places (some % in cash, some in savings account, some in INDEX funds etc) is good idea as per me..

[nix4me]

I do this but I use a more simple approach.

I hold 2 months in bank savings (1st tier)
I hold 2 months in BND in my brokerage (2nd tier)
Then I throw everything else into VTI in my brokerage (everything left after maxing 401k and Roth IRAs of course).

[willthrill81]

These are all assets that fluctuate in value. Maybe have 25% more than you need in case you need the money and the markets are all depressed.

I agree. Slightly 'overfunding' your EF can enable you to take on some volatility, at least enough to enable you to beat inflation.

[statefan03]

Thanks for the responses thus far. My question was more focused on given the decision to use a fund like this as the EF, what are the pros/cons to investing in the individual backing funds directly instead of the single fund provided by Fidelity.

Has anyone done this? Are the tax benefits worth the extra upkeep?

[willthrill81]

Thanks for the responses thus far. My question was more focused on given the decision to use a fund like this as the EF, what are the pros/cons to investing in the individual backing funds directly instead of the single fund provided by Fidelity.

Has anyone done this? Are the tax benefits worth the extra upkeep?

If you're going to hold the fund(s) in a taxable account, it might be better to hold separate funds as opposed to an all-in-one for tax purposes (i.e. you can sell whichever one produces the least taxes), but if you want to maintain a fixed AA, then you can just go with an all-in-one fund. Bonds in taxable aren't much of a tax drag these days due to their tiny yields.

[Jack FFR1846]

My answer is NO. Put the money back into your marcus account.

If you want to buys some iBonds over time, I have no problem with that. Only what you can do without for a year. Ladder more in each year and don't forget that you can get $5k in paper bonds from your federal refund.

[sapphire96]

My answer is NO. Put the money back into your marcus account.

If you want to buys some iBonds over time, I have no problem with that. Only what you can do without for a year. Ladder more in each year and don't forget that you can get $5k in paper bonds from your federal refund.

I have to second this. I am seeing, IMO, many Bogleheads moving their emergency fund into stocks. An emergency fund is supposed to be a readily-accessible, liquid, and safe asset for an unexpected/major event. Putting it into the market where the principal value can fluctuate up or down is starting to treat the emergency fund more like an investment rather than emergency fund. It also adds an additional level of complexity to your finances.

With that said, I like the idea as mentioned by Jack of putting the money into ibonds in a ladder approach. That way you have something that keeps up with inflation while still being safe and readily accessible (if you ladder it).

[MotoTrojan]

It’s all just weird mental accounting. If you hold equity, your EF needs to be larger. Why not just hold that equity in your core investment allocation, and hold your (now smaller) EF in cash or cash equivalents?

[willthrill81]

Poster vineviz started a thread specifically discussing this strategy not long ago. It's worth reading.

[jebmke]

Some of us have no emergency fund at all - which is somewhat similar to what you are suggesting with the added complication of an additional accounting. Whether that works for you depends on your personal situation which you haven't really described.

[mokaThought]

I formulated something along the same intent the other day for our emergency cash. It was essentially putting the first $5,000 in HYSA, next $15,000 in BSV (VG short-term bond), next $15,000 in BIV (VG interm-term bond), etc. There's definitely room for adjustment as time goes on.

[humblecoder]

I'm thinking if I purchase the individual funds myself instead of the FIKFX fund, I can:
1. Have lower expense ratios.
2. Have lower tax costs using more efficient ETFs.
3. Be able to TLH the individual funds at the end of the year even if the total portfolio is up.

[....]

So my question for you guys is, has anyone done anything similar and have any feedback? I'm thinking the possible drawbacks here are:

1. Trying to maintain my asset allocations over time.
2. If an emergency does happen and I need the money, I'll have to make multiple sell orders.

Your question is less about "whether is it a good idea to put your emergency fund in 'riskier than risk-free' assets" and more about "is it better to invest in a 'fund of funds' or just invest in the underlying funds myself". It seems like most of the responses are assuming you were asking the first question, when that wasn't your real question. Am I right?

On that assumption, it seems like you understand the advantages of each method, so there is nothing I can add. I also take a more DIY approach with some of my investments for the same reasons you list (cheaper, better control over taxes).

As far as the unasked question of whether this makes sense for your emergency fund specifically, there are many multi-page threads debating the merits of putting emergency funds in risky assets. In my opinion, that topic has been beaten to death, buried, resurrected as a vampire, stabbed through the heart with a wooden stake, and then buried again, so there is nothing that nobody is going to add to that topic on your thread, other than to drive the moderators crazy with "yet another emergency fund thread"!

[000]

Nope. Cash is the only thing that holds up in a liquidity crisis.

[Robert20]

I formulated something along the same intent the other day for our emergency cash. It was essentially putting the first $5,000 in HYSA, next $15,000 in BSV (VG short-term bond), next $15,000 in BIV (VG interm-term bond), etc. There's definitely room for adjustment as time goes on.

WHY not just invest in one fund? VGLT?

[snailderby]

Thanks for the responses thus far. My question was more focused on given the decision to use a fund like this as the EF, what are the pros/cons to investing in the individual backing funds directly instead of the single fund provided by Fidelity.

Has anyone done this? Are the tax benefits worth the extra upkeep?

Investing your emergency fund in six separate funds (VTI/VXUS/FXNAX/VGLT/VTIP/VGSH) seems unnecessary to me. First, we're talking about an emergency fund, not your retirement portfolio, so I wouldn't obsess over small differences in return. Second, a six-fund emergency fund would be a hassle to rebalance (or add and subtract to as needed).

If you value simplicity but want to invest a small portion of your emergency fund in stocks to juice returns, FIKFX (Fidelity Freedom Index Income Investor) seems like a reasonable choice. Alternatively, you could consider a two-fund combination of 20% VTI (Vanguard Total Stock Market ETF) or VT (Vanguard Total World Stock ETF) and 80% SCHR (Schwab Intermediate-Term US Trs ETF). That will (very roughly) approximate FIKFX without using six different funds.

[aristotelian]

This just means you are reducing your emergency fund by 20%. That is fine if you are OK with the risk. Personally I would stick with cash. Yields are low but that is just the price of safety in the current climate.

[Robert20]

market volatility measures section of morningstar shows like above for VGLT.. What does this mean?. How to interpret this?

[sycamore]

market volatility measures section of morningstar shows like above for VGLT.. What does this mean?. How to interpret this?

I don’t know the answer but do you see that (i) symbol in the image you posted? Click on it and I bet you’ll see some information about Market Volatility Measures.

[Robert20]

market volatility measures section of morningstar shows like above for VGLT.. What does this mean?. How to interpret this?

I don’t know the answer but do you see that (i) symbol in the image you posted? Click on it and I bet you’ll see some information about Market Volatility Measures.

this is what I see...

Upside Capture Ratio measures a manager's performance in up-markets relative to the index. A value over 100 indicates that a fund has outperformed the benchmark during periods of positive returns for the benchmark.

Downside Capture Ratio measures the manager's performance in down-markets relative to the index. A value of less than 100 indicates that a fund has lost less than its benchmark when the benchmark has been in the red.

Maximum drawdown is the peak-to-trough decline during a specific recorded period of a fund. It measures the largest percentage drawdown that has occurred in a certain time period.

[sycamore]

market volatility measures section of morningstar shows like above for VGLT.. What does this mean?. How to interpret this?

I don’t know the answer but do you see that (i) symbol in the image you posted? Click on it and I bet you’ll see some information about Market Volatility Measures.

this is what I see...

Upside Capture Ratio measures a manager's performance in up-markets relative to the index. A value over 100 indicates that a fund has outperformed the benchmark during periods of positive returns for the benchmark.

Downside Capture Ratio measures the manager's performance in down-markets relative to the index. A value of less than 100 indicates that a fund has lost less than its benchmark when the benchmark has been in the red.

Maximum drawdown is the peak-to-trough decline during a specific recorded period of a fund. It measures the largest percentage drawdown that has occurred in a certain time period.

Thinking out loud...

Sounds like Morningstar is comparing a fund (and the category that M* put the fund into) against an index. It's not obvious what that index is. Presumably M* explains that somewhere in their methodology and/or on each fund page (wherever you grabbed that screenshot from). But I'd want to know what the index is so I can put the upside/downside capture ratio in context.

For example VGLT has an upside and downside capture ratios of 238 and 302 (presumably based on past performance). I think that means 2.38 times and 3.02 times whatever the index is. So if the index goes up 30 points in a day, I guess the expectation is VGLT would go up 30 * 2.38. And the downside is even stronger.

Maybe a ratio greater than 100 is "a good thing"? Or Mmaybe it's bad? Seems like it depends on the index chosen by M*.
Maybe it's better to find a fund that has a upside ratio greater than its downside ratio?

Not sure of the answers so I'll try a google search...

Found something that provides answers:

...
An upside capture ratio over 100 indicates a fund has generally outperformed the benchmark during periods of positive returns for the benchmark. Meanwhile, a downside capture ratio of less than 100 indicates that a fund has lost less than its benchmark in periods when the benchmark has been in the red. If a fund generates positive returns, however, while the benchmark declines, the fund’s downside capture ratio will be negative (meaning it has moved in the opposite direction of the benchmark). All stock funds' upside and downside capture ratios are calculated versus the S&P 500, whereas bond and international funds' ratios are calculated relative to the Barclays Capital U.S. Aggregate Bond Index and MSCI EAFE Index, respectively. For some context, we also show the category average upside/downside capture ratios for those same time periods.

and there's a link Click here to learn more about these ratios and interpreting the numbers.

[snailderby]

As far as the unasked question of whether this makes sense for your emergency fund specifically, there are many multi-page threads debating the merits of putting emergency funds in risky assets. In my opinion, that topic has been beaten to death, buried, resurrected as a vampire, stabbed through the heart with a wooden stake, and then buried again, so there is nothing that nobody is going to add to that topic on your thread, other than to drive the moderators crazy with "yet another emergency fund thread"!

Lol. That's how I feel about the international threads that pop up every couple weeks.

[dknightd]

Thanks for the responses thus far. My question was more focused on given the decision to use a fund like this as the EF, what are the pros/cons to investing in the individual backing funds directly instead of the single fund provided by Fidelity.

Has anyone done this? Are the tax benefits worth the extra upkeep?

If you are going to consider moving your EF into a more diversified holdings, consider using a Roth account
https://www.bogleheads.org/wiki/Roth_IR ... gency_fund
Then tax considerations disappear I wish I had discovered this strategy years ago.