A good friend of mine met up with a financial planner to get his affairs in order, great plan right? Well that depends of course on the financial planner. First off, I am not a financial planner, but I play one on the Web. So I offered to weigh in for him on what his planner might recommend and he took me up on the offer. After all of their meetings and conversations, he concluded that my buddy is on the right track and the one thing he should do is move his $30,000 emergency fund. Where should he move it? Why to a High Yield Bond Mutual Fund of course! . Let’s look at the details:
The Financial Planners Emergency Fund Investment Recommendation
Starting Investment: $30,000
Investment Vehicle: High Yield Bond Mutual Fund
Front Load: 4.75%
5 year Total Return:3.05%
Amount Invested after Fees: $28,575
Liquidity: 5 Business days would be typical to get it somewhere you could use it.
Risk: Low, although funds are not backed by FDIC.
So essentially the planner is recommending that the emergency fund be used as an investment, which also means that it carries some risk and honestly a small amount of reward especially after you add the $1425 front load fee for purchasing this mutual fund.
FiscalGeek’s Emergency Fund Investment Recommendation
I don’t want to be misleading because my recommendation is to effectively not treat the emergency fund as an investment rather it’s use is for “EMERGENCIES!” That means that it needs to be there when you need it with no risk. The planner’s recommendation does not meet those goals.
Starting Investment: $29,000
Investment Vehicle: Ally Bank High Yield Online Savings Account
Fees/Load: None.
5 year Total Return: Not a straightforward calculation, Ally’s current rate is 1.70% but within the last year they’ve been at a high of 3.75%. They consistently are in the top of all online savings rates, as interest rates rise so will your return. Source
Amount Invested after Fees: $29,000
Liquidity: 2 business days would be typical to get it to another bank account, open up a lower yield money market and you can withdraw with a check card immediately.
Risk: I can’t with good conscience say none, but your money is protected by the FDIC up to $250,000 so unless the entire U.S. federal government goes insolvent (which some may argue they already are) your money couldn’t be much safer.
Hold on, you have only $29,000 as the starting investment, where did the other $1000 go? This depends on your paranoia level, but I would argue that it makes sense to have $1000 cold hard cash stashed somewhere nearby. Not your mattress, not your underwear drawer, but somewhere you could get at it in a matter of minutes if needed. This is the ultimate in liquidity and could come in very handy in some situations. No you’ll get no return on your investment, but that’s okay, that’s not what this money is for, it’s for your piece of mind. Frugal Dad has some great advice for places to hide cash, but I would only use these as inspiration just to be safe.
Why Ally Bank?
I don’t have a particular brand affinity for online savings accounts and many would work just as well. It’s just that Ally has one of the highest savings rates around and has consistently done that. Although today’s rate of 1.7% is nothing to write home about, it’s still free money, it’s terribly easy to use and setup an account online. And you can very easily transfer funds from your other checking/savings accounts to and from your Ally account. I’ve recently opened an account with them and it works fantastic. You could just as easily find a local credit union or neighborhood bank to deposit your emergency fund savings although doing some serious looking I could not locate a better rate. My credit union is small and offers a fantastic 7.71% on your first $750 account balance but after that it drops to .71%.
A High Interest Checking Account
Another option for those willing to jump through some hoops would be to open a high interest checking account, you can find many options at CheckingFinder and currently you can get rates up to 4.30% but it does come with a catch. You have to sign up for direct deposit and make at least 10 debit card purchases a month. This kind of defeats the purpose of an emergency fund. You should not be funneling your daily purchases through your savings. I would strongly recommend against this option, but wanted to present this as an option to the highly diligent and disciplined among you of which I am not a member.
Final Recommendations
So am I suggesting to my friend that he shouldn’t invest in mutual funds? Absolutely not, I think his next steps would to be just that assuming he’s paid off any outstanding debt. In fact I’d go so far as to say if he currently has outstanding debt that he should use a portion of his $30,000 to attack that debt first, and then go after the 3-6 months of expenses in an emergency fund, and then investing. Mutual funds are a great way to invest, it’s how I have directed my meager 401k savings to date, and what I will invest in once we are debt free and have saved our emergency fund. I would just suggest that you arm yourself with as much knowledge as possible and don’t take the advice solely of one individual on where to put your money. I love the statement that Dave Ramsey frequently makes which is that you should never put your money in anything you don’t understand. So it’s in your best interest before you act on anything to do some research.
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That’s a good analysis. If one wanted to invest their emergency fund, I would suggest learning what maximum drawdown they are willing to put up with. A high yield bond fund could decline by 20-25% during any short term horizon. Over time it may perform well, but if you have a 30k emergency fund, I wouldn’t count on more than 25k being there for withdrawal at any particular moment.
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Love your suggestion to put $1,000 in cash within reach in minutes. That’s something I never consider but really should.
Hopefully that planner didn’t charge your friend anything!
Oh but he did, at least he’s not getting the large commission on selling this bond.
Paul, great assessment. I hope the recommendation had some merit other than to put a little cash in the planner’s pocket.
I agree with Retirement Savior that a high yield bond can decline significantly (see 2008) during a short term horizon.
Maybe a $30k cash reserve is a little too much for this situation and a portion of the money could be invested for a short term horizon – but as always you must know yourself – your risk appetite and the purpose for you money before you make a significant decision like investing your emergency fund!
.-= Jason @ Redeeming Riches´s last blog ..Why You Need a Larger View of Your Money (And So Do I)! =-.
I wholeheartedly agree with the fiscal geek who plays a financial planner on the web.
Like you said, EF’s are not for investing… they’re for emergencies! And they need to be liquid.
I also agree with your recommendation to keep $1,000 stashed somewhere in your home. Good stuff Paul.
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My only twist on emergency fund I’d offer: If you don’t fund an IRA, only 401(k), by putting the emergency funds into a Roth, you have the potential for tax free growth, and 100% access to the deposited money at all times, so long as the funds within the Roth are kept liquid, money market/CDs. Over time, if your income grows, you may decide that you actually save in the Roth, for retirement, that’s when you’d fund emergency money outside the Roth.
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Thanks Joe for weighing in, always providing valuable insights.
Well said. But I’d probably go a bit further and suggest that your friend dump this particular financial planner forever.
If his advice about the emergency fund was this self-serving and inappropriate, I’d hate to think what he’d do if he had access to your friend’s retirement funds.
I’m with you Paul and I think he did just that.
What are you talking about? This was a great suggestion of the financial planner. How else would the planner make a lot of money? – I find it amazing that so called ” financial professionals” are free to roam and are free to work so blatantly for their own benefit rather than the benefit of the client. In the meantime, your suggestion is smack on. I especially like the idea to keep some money stashed away in hard cash.
.-= ctreit´s last blog ..Net Worth Calculator says dealing with financial emergencies and surprises is easy =-.
You said that the planner charged a fee as well? Then he tried to make mutual fund commissions? Was he able to convince your friend to buy anything from him? I would go as far as requesting the initial fee back due to poor recommendations. Most planners will come out and tell you that if you are unhappy with the process or the recommendations they will reimburse your fee. Have him write a letter to the planner requesting the fee back.
I’m in agreement with you and the comments. The money needs to be liquid not at risk. I like the Roth idea the problem is you can’t get all the money in there and hopefully he’s using it all ready. I don’t recommend CDs because they usually have some surrender charge tied to them.
.-= Evolution Of Wealth´s last blog ..Does His Sacrifice Define Him? =-.
Great post. Liquidity is so important. No point investing #30k and then not being able to access it in your hour of need.
@Kelly – I would even advise on installing a safe at home to store the cash in along with other goodies.
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I hope he took your advice. These financial planners are salesmen and this clearly is another case of why we need to avoid them. THey are not out to help us invest, but to skim off their take on our hard earned money.
Great advice here. I don’t think an emergency fund should be an investment. It should be readily available in case of an emergency. $1000 of cash on-hand, especially if you have a fully fund savings? Love it!
.-= Jason @ One Money Design´s last blog ..Retirement Week: A Solution to the Retirement Crisis =-.
Thanks for your post on how to invest. I do agree that “emergency money” should be easily available on the spot when it’s truly needed.
I think it’s a bit impractical to invest up to $30,000 as an “emergency fund”. If this money can’t be used right away, then you are stuck without it.
I worked in banks for a long time and I have seen this type of advice given over and over again. Customers often asked me what I thought and I used to give them my honest response which was based on what I would do in their situation.
I really think that the first priority is to keep plenty of cash as an emergency fund. Sure, you can invest the rest, but keep that emergency fund even if interest rates are low.
You never know what life night throw at you and it’s sensible to be able to lay your hands on some fast cash if you need to do so.
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Interesting piece! Do you have any opinions that you maybe willing to divulge to illustrate your first point a bit more? thanks