Ask people where to keep your emergency fund and you’ll get a nearly-unanimous response of ‘savings account at a bank or credit union’. Generally speaking this is sound advice. You want to keep money somewhere safe and secured, that can be accessed quickly. But there’s a problem with that approach: opportunity cost.
I can hear the gasps already. An emergency fund is FOR EMERGENCIES. It makes sense to keep it in an extremely safe, secure, and easy-to-access account, and for that task, few things are better than a boring old savings account.
But I’m a bit risk tolerant, and I’m not cool with the idea of thousands of dollars sitting there, with me paying a premium (inflation rate – yield on account) to keep my money safe. I’d rather have some of that money do something for me.
And so, we’re starting our Hybrid Emergency Fund.
The Hybrid Emergency Fund
The concept of our hybrid emergency fund is pretty simple. We’re going to pair the boring, safe savings account with a taxable account invested in index funds. Doing so will give us some of the stability and security of a regular savings account, but will mitigate our losses to inflation through potential market gains.
For starters we’ll keep 3 months of expenses in a high yield savings account. This is money that we’ll tap first, and for most foreseeable emergencies this should be sufficient. Most situations that we’d encounter won’t require immediate cash in excess of 3 months of expenses, which is why we’re keeping that amount in there.
We’re parked in a Money Market account (yielding 1.1% at the time of this article). I could chase another .05% and switch to Ally, but I’ve been a CapOne customer since the ING days and at this point moving it would be more trouble than it’s worth. If we get into talks about bonuses from opening accounts, I may have a change of heart. For now, this works.
Our brokerage account will round out the remainder of our hybrid emergency fund. Since we already have 3 months’ worth of expenses in liquid cash – and generally the advice is “3-6 months expenses” for an emergency fund, we could be done if we wanted to.
But we’re going to plan on keeping an ADDITIONAL 6 months of expenses in a brokerage account, which will only be tapped in case of an emergency.
Why six months? For starters, as a brokerage account it can (and sometimes will) lose value. Since we’ve already got 3 months, we figured an additional 6 would give us enough buffer that if the market took some hits, we would still be fine. If it loses more than half of its value and it coincided with us needing to tap the money, we’d be in a tight spot potentially, but there are some ways we can get around that. More on that later.
We’ve settled on Vanguard as the home for this account, and will be investing in index funds. Our primary investment will be VTSAX which is very popular among the personal finance crowd, and we may put a smaller percentage into a more targeted fund, but that is still TBD.
Few scenarios in life would require an immediate need for more than 3 months’ worth of expenses in a single day, that day. If we need more money than what we have in liquid savings, we’d need to sell some stocks and it’d take us a couple days to sell/transfer the money. Overall, probably not a huge risk here.
But there are some situations where, if we hit some sort of catastrophic failure, we’d be completely SOL.
That magnitude of failure is relatively unlikely to occur. It could involve the following (or similar) events, all coinciding with each other:
- Loss of income for both me and Kristin (we both make enough to cover our main bills in the event just one of us loses our job)
- Major health crisis not covered by insurance (and no negotiation on repaying those medical bills)
- Total market crash, wiping out the entirety of our brokerage account (in which case all hell is breaking loose anyway)
If all three of those panned out simultaneously, we’ll have more concerns than no money. It’ll be some sort of life-threatening condition, anarchy or total war; health, food and safety would be our primary concerns in these cases.
Still, we do expose ourselves to some degree of risk if the market does perform extremely poorly for an extended period of time and we lose both incomes. Overall, it’s a risk we’re willing to take.
To help mitigate some of the risks, we have a few options. For starters, we’re basing all of our expenses on “fat” months. What I mean by that is, we have lots of expenses we can EASILY ditch. Things like going out to eat, extra entertainment (date night) expenses, travel above and beyond commuting for work, and other miscellaneous stuff.
These eat at our budget but improve our quality of life – that’s something we’re willing to deal with. If it all hits the fan, though, those things will be the first to go. We can stretch our 3 months in liquid savings to something closer to 4-5 without much hassle.
The other thing we’re doing, that’s worth repeating, is keeping an additional 6 months of expenses in our brokerage account that won’t be touched. That effectively would give us +/- 9 months (with a stretch goal of 11-12 months) worth of expenses that’s not to be touched except for in an emergency. Of course, when the markets go down, that might put a little pinch on us, but that’s part of the risk we’re willing to take.
Over time we’ll continue to contribute to our brokerage account. It’ll grow past the 6 months, and if the market moves upward – as is the trend – it’ll grow just by itself. That’s the hybrid portion of our emergency portfolio. Once we’ve amassed 6 months of expenses, any extra contributions – which will happen regularly – will be gravy.
That money won’t necessarily be earmarked strictly for emergencies, however. Assuming monthly “fat” expenses of $4000, a 6-month brokerage account would need $24k in assets. If that account grows to $30k, we’ll give ourselves $6k of wiggle room for ‘other stuff’. That may mean selling a little bit toward the purchase of a rental property. It may just mean having some extra cash sit there and grow (the more likely scenario).
Outgrowing the Emergency Fund
Eventually I think it’s a natural progression to sort of ‘outgrow’ just a regular emergency fund. When you’re able to max out tax-advantaged accounts and just have extra disposable income, it’s got to go somewhere. We’re not ones to spend a ton of money on stuff, so investing is a natural transition for us.
We’ll change our strategy as our lives evolve and our needs evolve. Over time we’ll likely continue to add smaller amounts of money to liquid savings. It’ll be the first thing we tap if we need it, and it’ll be the first thing we replenish if we need to dip into both.
It’s an important safety net, but since we both hate the opportunity cost, we’re still on the relatively lean side for how much we’ll keep in there.
Do you think investing a portion of your emergency fund is smart, or crazy? Would you ever consider doing something like this?