Why not use TIPS for emergency fund?

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kjm
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Why not use TIPS for emergency fund?

Post by kjm »

Would it be a bad idea to use TIPS for my emergency fund? The only potentially dangerous scenario I could imagine would be deflation. Anyone put any thought into this?
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Index Fan
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Post by Index Fan »

I prefer to have a non-volatile emergency fund (FDIC-insured savings account). I like TIPS and have money invested in the Vanguard TIPS fund, but they can be volatile. In 2008, they suffered from liquidity issues and they finished the year down -2.85% (compared to a +5.05% gain for the Total Bond Market Index).

Image

Sure, 2008 was an exceptional year hopefully not to be repeated soon, but it showed that TIPS as an asset class can react unpredictably. I want my emergency fund to be very predictable and boring.
Last edited by Index Fan on Sat Oct 16, 2010 9:33 pm, edited 1 time in total.
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Karamatsu
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Post by Karamatsu »

I divide my emergency fund between cash and redeemable government savings bonds. I wouldn't want to put everything in bonds because Murphy's Law predicts that, when I do face an emergency, it will be on the Friday night before a three-day weekend. In the US you could probably handle even those sorts of things with just a credit card, but, as they say, Murphy was an optimist.
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nisiprius
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Post by nisiprius »

I love TIPS to pieces but I would not consider them as a first-line emergency fund, for the reasons graphically illustrated in Index Fan's posting, blue line above.

In a true emergency anything goes, and, yes, I believe I can sell my TIPS or a TIPS fund at will--and that even if I sell them at a really bad time I'm probably talking about 15% down, not 50% down. I think 2008-2009 above can be taken as a good example of something close to the worst-case scenario. But the prospect of having to sell them when they're 15% down is pretty painful to contemplate.

In sharp contrast, series I savings bonds, which are also inflation-protected, are completely free from market fluctuation. Once you're past the first year, there is no such thing as a bad time to redeem them. (Although due to the penalty it's probably best to avoid redeeming within the first five years). They up steadily in real value, month after month. They're the closest thing I know of to a truly riskless investment. Too bad they a) pay so little, b) have such a small purchase limit, and c) can't be held in a Roth IRA. I definitely consider my series I savings bonds to be part of my emergency fund.
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Doc
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Post by Doc »

If you use individual TIPS instead of a fund you can avoid the problems noted above. BUT you need to sell each TIPS when the maturity is less than 2 or 3 years and replace it with a nominal Treasury of similar maturity. In that short time frame, inflation should not be much of a risk. You do need to incur some transaction costs which may make the idea prohibitive for smaller accounts.

I adopted this procedure after the 2008 meltdown and am converting my 0 to 10 yr TIPS ladder to 3-10 years plus a 0-3 nominal Treasury (step) ladder.
A scientist looks for THE answer to a problem, an engineer looks for AN answer and lawyers ONLY have opinions. Investing is not a science.
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