Clever Strategy for "Emergency Fund" Money

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ObliviousInvestor
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Clever Strategy for "Emergency Fund" Money

Post by ObliviousInvestor » Mon Jan 31, 2011 12:14 pm

Personal finance blog Five Cent Nickel had a post today that I thought some of you might find helpful: http://www.fivecentnickel.com/2011/01/3 ... gs-yields/

One thing he suggests that I haven't read about in many places is the idea of "parallel CDs." For example, if you have $20,000 that you want to put into a 5-year CD, it may be better to do 4 $5,000 5-year CDs to minimize the penalty if you end up needing to access some (but not all) of the money before the maturity date.
Mike Piper, author/blogger

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Post by tludwig23 » Mon Jan 31, 2011 12:21 pm

Allan Roth (CBS Moneywatch contributer) has also long been a fan of this technique. For example, see:

http://moneywatch.bnet.com/investing/bl ... blog-river

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Post by ruanddu » Mon Jan 31, 2011 1:13 pm

Seems to be a sound idea to me. I'd only worry about locking too much money in a 5 year CD right now due to the low rates. Hopefully rates will start to climb again in the near future.

Josh

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Purpose of EF

Post by calminvestor » Mon Jan 31, 2011 1:19 pm

Liquidity of an EF is one of the most important factors in deciding where to hold your EF. You may be overthinking this. This is where you need to decide if this money is primarily for an investment (if so, CD's suck) or is this money to be used in an emergency.
Keep it in a Money Market Fund - it's liquid and earns more than a standard savings account (granted, not much).

If your transmission goes out, the last you'll want to worry about is messing arond with taking some penalty on a 5-yr CD or how long it'll take to get your cash. In an emergency, you won't want to be worrying about how to be strategic. You just want to get something fixed so you can get back to your life. Liquidity rules for an EF. Forget about making it an investment too.

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Post by jmg229 » Mon Jan 31, 2011 1:27 pm

I believe the point that was being made is that if you find a bank such as Ally that has a low withdrawal penalty (60 days in that particular case), the money is still liquid enough to act as an emergency fund. I'm not sure what if any lag there is between making the decision to withdraw money and actually getting, but this would obviously be key to consider.

The other advantage of this, to respond to ruanddu, is that your money isn't truly locked in. If rates increase enough, you can forgo 60 days (or whatever the case may be) of interest and reinvest it in a CD with a higher rate. You are essentially betting that it will take long enough for rates to increase that sacrificing the 60 days worth of interest still keeps your total yield higher than that of a money market account.

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Post by exigent » Mon Jan 31, 2011 2:11 pm

The main lag time will be associated with pulling the money to your local bank via ACH. You should be able to access the money in a few days tops. As for liquidity being important, that's definitely true, but many people sit on 6-12 months (or more). There's no need to keep that full amount sitting in a savings or MM account earning a pittance.

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Post by AZK » Mon Jan 31, 2011 2:23 pm

I don't understand the draw to CDs or Money market funds for short term emergency cash. If you carry a high enough balance some checking/savings accounts are comparable and the cash is liquid.

i.e. ING electic orange, if balance is >50k you get 1.1 or 1.2%. Meanwhile the best I can get on a CD is 1.3% and if I withdrawal early I get penalized....

Seems like a no brainer to me.

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Post by Chin Strap » Mon Jan 31, 2011 2:24 pm

AZK wrote: i.e. ING electic orange, if balance is >50k you get 1.1 or 1.2%. Meanwhile the best I can get on a CD is 1.3% and if I withdrawal early I get penalized....


Look harder. Ally 5 year is far better than that, and with really lenient early withdrawal fees.

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Post by tludwig23 » Mon Jan 31, 2011 2:41 pm

Chin Strap wrote:
AZK wrote: i.e. ING electic orange, if balance is >50k you get 1.1 or 1.2%. Meanwhile the best I can get on a CD is 1.3% and if I withdrawal early I get penalized....


Look harder. Ally 5 year is far better than that, and with really lenient early withdrawal fees.
PenFed 5yr/7yr is 2.5%/3.0%

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Post by Ody » Mon Jan 31, 2011 2:41 pm

I like using a credit card as my vehicle of choice for accessing my emergency fund. This way I have 30 days to transfer the money from the CD where the money is sitting and don't have to worry about immediacy issues.
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Post by Chin Strap » Mon Jan 31, 2011 2:43 pm

tludwig23 wrote:
Chin Strap wrote:
AZK wrote: i.e. ING electic orange, if balance is >50k you get 1.1 or 1.2%. Meanwhile the best I can get on a CD is 1.3% and if I withdrawal early I get penalized....


Look harder. Ally 5 year is far better than that, and with really lenient early withdrawal fees.
PenFed 5yr/7yr is 2.5%/3.0%
With a 6 month early withdrawal fee vs. 2 for Ally. I would call that less liquid.

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Post by porcupine » Mon Jan 31, 2011 3:04 pm

Chin Strap wrote:With a 6 month early withdrawal fee vs. 2 for Ally. I would call that less liquid.
I disagree! If the money is as accessible in one place as it is in the other, they are equally liquid. If it takes two weeks to get your money out at PenFed vs. two days at Ally, then yes, Ally money would be more liquid.

Of course, it costs 6 months of interest at Penfed vs. 2 months of interest at Ally, but that is a different issue, not that of liquidity or lack thereof.

- Porcupine

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overthinking

Post by calminvestor » Mon Jan 31, 2011 3:09 pm

overthinking.

Where does grandma keep her purse? Close. Why? Cause she might need her lipstick. Duh!

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Post by tludwig23 » Mon Jan 31, 2011 4:04 pm

porcupine wrote:
Chin Strap wrote:With a 6 month early withdrawal fee vs. 2 for Ally. I would call that less liquid.
I disagree! If the money is as accessible in one place as it is in the other, they are equally liquid. If it takes two weeks to get your money out at PenFed vs. two days at Ally, then yes, Ally money would be more liquid.

Of course, it costs 6 months of interest at Penfed vs. 2 months of interest at Ally, but that is a different issue, not that of liquidity or lack thereof.

- Porcupine
I agree with porcupine.

I also think how you set up your emergency fund depends, in part, on the probablity you will need to use it. I my case, my spouse and I both are employed, in different industries. If either can't work the other one can just work more (within limits) to make up the difference. Therefore the chances I will need to tap in are low.

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Post by kirent » Mon Jan 31, 2011 4:14 pm

The Ally CD is considered a better deal if you intend for your CD to be liquid, while the PenFed CD is better if you intend to keep your CD until maturity. Local credit unions can offer a better deal than both.
Disclaimer: I am not a financial or legal expert and all information I provide is given for entertainment purposes only, at your own risk and with no guarantees of accuracy.

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Post by tludwig23 » Mon Jan 31, 2011 4:19 pm

stives wrote:The Ally CD is considered a better deal if you intend for your CD to be liquid, while the PenFed CD is better if you intend to keep your CD until maturity. Local credit unions can offer a better deal than both.
In what way is a PenFed CD not liquid?

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Post by Chin Strap » Mon Jan 31, 2011 4:23 pm

tludwig23 wrote: In what way is a PenFed CD not liquid?


You usually don't want to put emergency funds in a thing that loses money. There is 3x as long amount of time you have to wait for a PenFed CD to not lose money vs. an Ally one. Sure, if you get the ladder in place and only need to cash in one that is farther than 6 months mature already, then they are equivalently liquid.

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Post by ObliviousInvestor » Mon Jan 31, 2011 4:29 pm

porcupine wrote:If the money is as accessible in one place as it is in the other, they are equally liquid. If it takes two weeks to get your money out at PenFed vs. two days at Ally, then yes, Ally money would be more liquid.
Agreed. It seems to me that liquidity and possibility/probability of loss are different things.
-Investment property, art/collectibles, and hedge funds are not liquid, since you cannot quickly turn them into cash.
-Stocks, bonds, money market, and CDs (as long as you can break them early) are liquid.
-Cash, checking, and money market accounts with a debit card are even more liquid.
Mike Piper, author/blogger

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Post by kirent » Mon Jan 31, 2011 4:41 pm

tludwig23 wrote:
stives wrote:The Ally CD is considered a better deal if you intend for your CD to be liquid, while the PenFed CD is better if you intend to keep your CD until maturity. Local credit unions can offer a better deal than both.
In what way is a PenFed CD not liquid?
I never said that it wasn't liquid. I said that if you intend for your CD to be liquid, then the Ally account is a better deal. That is because you will have had a higher return rate from the Ally CD if you withdraw funds from your CD anytime within the first four years.
Disclaimer: I am not a financial or legal expert and all information I provide is given for entertainment purposes only, at your own risk and with no guarantees of accuracy.

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overthinking

Post by calminvestor » Mon Jan 31, 2011 4:46 pm

overthinking...

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Post by tludwig23 » Mon Jan 31, 2011 5:54 pm

stives wrote:
tludwig23 wrote:
stives wrote:The Ally CD is considered a better deal if you intend for your CD to be liquid, while the PenFed CD is better if you intend to keep your CD until maturity. Local credit unions can offer a better deal than both.
In what way is a PenFed CD not liquid?
I never said that it wasn't liquid. I said that if you intend for your CD to be liquid, then the Ally account is a better deal. That is because you will have had a higher return rate from the Ally CD if you withdraw funds from your CD anytime within the first four years.
"intend for your CD to be liquid" doesn't make sense. Ally and PenFed CDs both are liquid. Liquid isn't a verb. Perhaps you meant, "intend for your CD to be liquidated."

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Post by sommerfeld » Mon Jan 31, 2011 6:29 pm

Ody wrote:I like using a credit card as my vehicle of choice for accessing my emergency fund. This way I have 30 days to transfer the money from the CD where the money is sitting and don't have to worry about immediacy issues.
what if the emergency included your credit card company cutting you off?
(I've seen it happen with a HELOC).

I keep a portion of our emergency fund in a savings account at the same credit union where we pay our bills; through their web site, I can transfer money in real time between accounts even after hours.

The rest is a bit further away.

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Post by kirent » Mon Jan 31, 2011 6:32 pm

tludwig23 wrote:
stives wrote:
tludwig23 wrote:
stives wrote:The Ally CD is considered a better deal if you intend for your CD to be liquid, while the PenFed CD is better if you intend to keep your CD until maturity. Local credit unions can offer a better deal than both.
In what way is a PenFed CD not liquid?
I never said that it wasn't liquid. I said that if you intend for your CD to be liquid, then the Ally account is a better deal. That is because you will have had a higher return rate from the Ally CD if you withdraw funds from your CD anytime within the first four years.
"intend for your CD to be liquid" doesn't make sense. Ally and PenFed CDs both are liquid. Liquid isn't a verb. Perhaps you meant, "intend for your CD to be liquidated."
You are correct. My responses are a bit rushed so don't mind my grammar.
Disclaimer: I am not a financial or legal expert and all information I provide is given for entertainment purposes only, at your own risk and with no guarantees of accuracy.

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Post by Febreze » Tue Feb 01, 2011 10:10 am

sommerfeld wrote: what if the emergency included your credit card company cutting you off?
I agree it makes sense to think of these sorts of things but in reality, I dont find it likely that all of my CC companies will cut me off at the same time, during my emergency.

First I have to define an emergency.

It's something that happened very fast, requiring a lot of money, in a short time period, for something unexpected.

The chances of my CC company finding out that I am in a bad financial position, and cutting me off over that very short period of time, is unlikely. CCs normally wont cut you off unless you start making late payments somewhere.

If you define an emergency as:

Well I lost my job 6 months ago, and now I got skin cancer that I ignored for 2 years and the hospital wont operate unless I get $5k cash together, AND my landlord has filed eviction papers because I havent paid rent in 2 months, AND I am 90 days late on all my credit cards...

If that's your emergency then yes, you are at high risk of the CC cutting you off. In my opinion you should have tapped into the emergency fund before you started paying the CC late.

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Post by lazyday » Tue Feb 01, 2011 4:06 pm

I think it's smart to diversify a little. More than one bank account. ibonds. Maybe Treasury Direct. Maybe a bond fund in taxable, but not much $ unless muni.

Most of the above can be small, with the favourite one(s) holding the majority.

Not sure if true, but heard that some people after Katrina had trouble accessing their money for basic needs, before the vouchers. A couple sources could reduce the chance of something like this.

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Post by sommerfeld » Tue Feb 01, 2011 6:34 pm

Febreze wrote:
sommerfeld wrote: what if the emergency included your credit card company cutting you off?
I agree it makes sense to think of these sorts of things but in reality, I dont find it likely that all of my CC companies will cut me off at the same time, during my emergency.
I'll note that the post I responded to said "a credit card".

Lenders are arbitrary and capricious when it comes to extending and withdrawing credit. If you trust them, they will screw you.

I have seen a HELOC cut off in the middle of a renovation that was being funded from the HELOC. The HELOC was current and the balance was nowhere near the credit limit. The borrower's income was sufficient and her job was not at risk. The total of the HELOC credit limit + mortgage balance was well under the assessed value of the house.
A different lender refinanced the HELOC without any difficulties other than adding a delay of a few weeks to the project.

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Post by LH » Tue Feb 01, 2011 7:35 pm

ObliviousInvestor wrote:
porcupine wrote:If the money is as accessible in one place as it is in the other, they are equally liquid. If it takes two weeks to get your money out at PenFed vs. two days at Ally, then yes, Ally money would be more liquid.
Agreed. It seems to me that liquidity and possibility/probability of loss are different things.
-Investment property, art/collectibles, and hedge funds are not liquid, since you cannot quickly turn them into cash.
-Stocks, bonds, money market, and CDs (as long as you can break them early) are liquid.
-Cash, checking, and money market accounts with a debit card are even more liquid.
So a 529 is liquid then? Your kids ugma account is liquid too?

Maybe so.

But consider this, the penalty part of that, is COMPLETELY illiquid as you lose it forever.

So, if one has 100 bucks in something that has a ten percent penalty, yeah you can get 100 out quickly, you must pay 10 bucks gone forever. To say that 10 dollars is liquid.....

Why not consider a credit card check liquid?

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Post by ObliviousInvestor » Tue Feb 01, 2011 8:00 pm

LH wrote:So a 529 is liquid then?
Great question/point. I suppose I would say that if you can get to the money quickly (which I don't honestly know if you can), then it's 90% liquid.
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Post by stevewolfe » Tue Feb 01, 2011 9:59 pm

Chin Strap wrote:
tludwig23 wrote: In what way is a PenFed CD not liquid?


You usually don't want to put emergency funds in a thing that loses money. There is 3x as long amount of time you have to wait for a PenFed CD to not lose money vs. an Ally one. Sure, if you get the ladder in place and only need to cash in one that is farther than 6 months mature already, then they are equivalently liquid.
Not true. The PenFed CD does not withdraw more than the interest earned. So if you cash the 5 year CD after 4 months you don't lose 4 months interest + 2 months interest from principal - you get back your original principal.

I just verified this by re-reading the early withdraw penalty section from a PenFed CD.

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Separate Emergency Fund ?

Post by Taylor Larimore » Tue Feb 01, 2011 10:21 pm

In my opinion, the idea that everyone needs a separate emergency fund is a myth.

Ask yourself: "In an emergency, do I have an available source of money?" The answer for many is "yes." If necessary, we can obtain cash from an ATM, credit cards, portfolio, bank loan, insurance policy, family, etc..

Not everyone requires a separate, low yielding, emergency fund that may never be needed.
"Simplicity is the master key to financial success." -- Jack Bogle

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Post by Chin Strap » Tue Feb 01, 2011 10:30 pm

stevewolfe wrote:
Chin Strap wrote:
tludwig23 wrote: In what way is a PenFed CD not liquid?


You usually don't want to put emergency funds in a thing that loses money. There is 3x as long amount of time you have to wait for a PenFed CD to not lose money vs. an Ally one. Sure, if you get the ladder in place and only need to cash in one that is farther than 6 months mature already, then they are equivalently liquid.
Not true. The PenFed CD does not withdraw more than the interest earned. So if you cash the 5 year CD after 4 months you don't lose 4 months interest + 2 months interest from principal - you get back your original principal.

I just verified this by re-reading the early withdraw penalty section from a PenFed CD.
Oh excellent. Didn't realize that. Still there is some break even point math that means for some short term horizon the Ally is better than the PenFed, but that is just pedantic at this point.

Either way, there are 5 year CDs that are essentially really good stealth 1 year CDs.

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Re: Separate Emergency Fund ?

Post by Scott S » Tue Feb 01, 2011 11:51 pm

Taylor Larimore wrote:In my opinion, the idea that everyone needs a separate emergency fund is a myth.

Ask yourself: "In an emergency, do I have an available source of money?" The answer for many is "yes." If necessary, we can obtain cash from an ATM, credit cards, portfolio, bank loan, insurance policy, family, etc..

Not everyone requires a separate, low yielding, emergency fund that may never be needed.
Thanks, Taylor. I've disciplined myself to keep 3-4 months worth of expenses in the bank, but it seems like a waste not to put the rest to work -- even though it will fluctuate more.

- Scott
My Plan: (Age-10)% in bonds until I reach age 60, 50/50 thereafter. Equity split: 50/50 US/Int'l, Bond split: 50/50 TBM/TIPS.

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Re: Separate Emergency Fund ?

Post by Tuxx » Wed Feb 02, 2011 1:16 am

Taylor Larimore wrote:If necessary, we can obtain cash from an ATM, credit cards, portfolio, bank loan, insurance policy, family, etc..
Slippery slope........

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Post by ruanddu » Wed Feb 02, 2011 2:43 pm

Taylor - I am interested in where you'd recommend putting savings/emergency funds into? Specifically, where do you keep your savings money that will use for say home repair/car repair, vacations, etc? Do you use rule of thumb for X amount of months of savings/emergency?

In my opinion, it seems like a online savings account with a high yield (Capital One, 1.3% as an example) seems a good place for the savings I mentioned above. What do you think? What do you do for your emergency fund? Are the funds invested into your regular portfolio?

Thanks,
Josh

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Emergency Fund--answer to questions

Post by Taylor Larimore » Wed Feb 02, 2011 5:02 pm

ruanddu wrote:Taylor - I am interested in where you'd recommend putting savings/emergency funds into? Specifically, where do you keep your savings money that will use for say home repair/car repair, vacations, etc? Do you use rule of thumb for X amount of months of savings/emergency?

In my opinion, it seems like a online savings account with a high yield (Capital One, 1.3% as an example) seems a good place for the savings I mentioned above. What do you think? What do you do for your emergency fund? Are the funds invested into your regular portfolio?

Thanks,
Josh
Hi Josh:

I remember in March, 2000, during our first Boglehead Reunion at my home, Mr. Bogle was answering a question about "emergency funds." We do not have a separate emergency fund so I whispered to Mel who was with me in the back of the room, "Do you have a separate emergency fund?" He whispered back: "No."

Like most retirees, our portfolio is the largest it has ever been. Accordingly, if we have an unexpected expense, I just sell shares of whatever is overweight in our asset-allocation plan. We value simplicity so an unneeded separate emergency fund is a no-brainer decision for us.

For an invester with a small portfolio, I think it is reasonable to keep enough in a bank account for "home repair/car repair, vacations, etc?" To me, it is not worth a separate small fund, with restricted liquidity, to try and eke out a bit more return.

A Roth can be an excellent emergency fund for an emergency described as a large unexpected expense. Roth contributions are available without tax or penalty at any time. Earnings are tax-free unlike a savings account or CDs.

There is more than one road to Dublin.
"Simplicity is the master key to financial success." -- Jack Bogle

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Post by ruanddu » Wed Feb 02, 2011 5:42 pm

Thanks, Taylor. I plan to max out our Roth IRA this year for my wife and I ($10,000). If I understand you correctly, there is no penalty for taking out the contributions at any time? Only if you take out the earnings before age 59 1/2?

In addition to maxing out the Roth IRA, do you or anyone else have suggestions for a good place to keep savings/emergency funds that can earn interest instead of sitting idle?

Thanks,
Josh

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Post by ObliviousInvestor » Wed Feb 02, 2011 5:46 pm

ruanddu wrote:There is no penalty for taking out [Roth] contributions at any time? Only if you take out the earnings before age 59 1/2?
That's correct. (Note, however, that amounts converted from a traditional IRA do not work like regular Roth contributions.)
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