Our family has been out of debt for a while now, and one of the first things we did after dumping all of our debt was to increase our $1000 emergency fund to better be able to cover us in case of larger emergencies, not just small emergencies.
First we built up a 6 month reserve in our savings account. After we had built up 6 months in reserve, the economy had already tanked and my wife had quit her job to become a stay at home mom, so we decided that we'd like to bump up our reserves to cover 12 months of expenses instead.
We've now saved up that 12 month emergency fund, and we feel pretty secure should I lose my job or have another major health issue. One thing that we have thought about, however, is if we should invest a portion of our emergency fund?
Where Emergency Funds Traditionally Go: Savings, Money Market
When you read up on the traditional advice on where to put your emergency savings you'll get some very conservative answers, usually ranging from a liquid checking, savings or money market account. Some will say to keep a small emergency fund of $1000 or more in your local checking. Next keep the rest of your emergency fund in a savings account earning the best interest that you can get. In this interest rate environment that is typically no more than 1% or so. Not much to write home about.
We're currently using this strategy with $1000 in a local checking account, and then the rest of our 12 month emergency fund in an Ally Bank savings account. The money in that account is earning less than 1% right now.
CDs Or A CD Ladder
Some people suggest taking a different strategy where you keep a few months of savings in your local checking and online savings accounts (like 3 months), and then putting the rest of it in a CD Ladder where you're earning a bit more on the money, while still leaving the money available within a few months if you really need it after your 3 months of savings in your liquid accounts. Another idea is to put the money in CDs that have smaller penalties for withdrawing early – in case you need to. For example, Ally has a 2 month interest penalty for early withdrawal, while others can have penalties upwards of 6 months interest. Be sure to check.
Investing In The Stock Market
Some people think that investing in the stock market with a portion of your emergency fund can be a good plan. Just make sure that you do have enough liquid funds (like 3-6 months) you can access right away, and then invest the rest, with the assumption that you could lose some of that principal.
One of the best options that I've heard of is to use your Roth IRA as a place to put some of your emergency fund. Since you can withdraw your contributions without penalty with a Roth, that can be a legitimate option for emergencies that crop up that won't create unnecessary penalties or tax burdens.
Investing in a more liquid stock investment like Betterment.com or through another brokerage account where you can withdraw your money at any time can also be an option. Just remember that you could be forced to sell at a time when the market is down cementing losses, or creating taxable earnings.
I think the biggest thing you have to contend with here is the risk that is inherent in the stock market, where you could in fact lose a large portion of your money at any time. So is that really something you want to do with emergency funds that you really want to be there and be liquid?
Investing In Lending Club
Another place that I've heard of some people investing a portion of their long term emergency cash is at Lending Club.
Typically Lending Club investors can get somewhere in the neighborhood of 9-12% returns depending on how much risk they take on. While the returns can be pretty good, the funds you're putting with Lending Club are typically going to be in 3-5 year loans, so the money isn't terribly liquid if you need the money right away. You can always sell the notes on the secondary market, but you may end up losing quite a bit that way. You also have the risk of borrowers defaulting on their loans, although you can pretty well diversify your risks with Lending Club.
If I were to head down this road, it would only be with long term emergency funds, and not money I would need right away.
Our Current Strategy
I am by nature pretty conservative when it comes to our emergency funds, and I currently keep all of it liquid in either a checking or savings account, earning around .90% interest. While I'd like to be earning more interest on the money, I just like having that money there and available should we need it – and I think my wife also needs it even more than I do to have that sense of well being. If I were to put a big chunk of it in some sort of investment I don't think she would have as much peace of mind.
Going forward I think we'll continue our strategy, but if we build up and above the 12 months in savings, we may end up investing a portion of that somehow. I'm not sure how we'll do that quite yet, but we'll see.
What are you thoughts? Would you ever invest a portion of your emergency fund? Why or why not?