What Should We do With Our Emergency Fund?

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Based on our current spending, our family has enough in our emergency fund to cover 9.5 months of expenses. If we immediately cut out all non-essential items, we could quickly have enough to cover 12 to 15 months worth of spending from our emergency fund.

Hopefully that scenario will never happen … but it gives us options and flexibility if we ever needed to use these funds.

In the past, we built a CD Ladder for our emergency fund … which would earn us close to $1,000 per year when interest rates were higher.

However, with a drop in interest rates over the last several years, the $1,000 return has quickly dropped to under $400 per year. Still not bad … but we probably can do way better and still carry low risk.

For those who are not familiar with a CD Ladder, here is a quick recap.

How to Build a CD Ladder

A CD ladder is a way of investing in multiple CDs (or certificates of deposit), so that they mature at staggered intervals. The total investment should be split evenly between each certificate of deposit within the ladder.

And intervals between different CDs should be at equal lengths, such as every 6 months, 12 months, etc.

Compared to a single CD investment, a CD ladder should get you a higher rate of return on your investment, while not sacrificing accessibility to all of your money.

Our Emergency Fund – Current Return on Investment

At the time of this writing, we have a little over $47,000+ allocated to our emergency fund. While we want these funds to be somewhat liquid (meaning we can get to them quickly if needed), we want to try and maximize our return.

For the past year, as our last certificate of deposit accounts have been expiring, we have held the majority of our funds in a money market account earning .75%. Not horrible when you compare it to a savings account … but not great either.

We have been hesitant on keeping our CD ladder going with such low interest rates. The current annual return on our emergency fund is $353.52 if we were to take no action and leave it in the money market account.

Current Annual Return = $353.52

However, through our local credit union, we have the option to build a new CD ladder with slightly higher rates. Here is a breakdown of options we have –

  • 0 Month Money Market – 0.75%
  • 6 Month CD – 1.00%
  • 12 Month CD – 1.25%
  • 18 Month CD – 1.25%
  • 24 Month CD – 1.50%

While these rates are not awesome … they are higher than 0.75% that we are earning now, and way higher than our current savings account.

Based on the CDs listed above, we have a few options to help maximize our returns while still having access to most of our emergency funds.

Note – Building a CD ladder assumes that when one account expires, the funds would be reinvested into the largest account previously setup.

6 Month CD Ladder

The first option we have would be to split our emergency into 2 equal investments for a 6 month ladder. So basically we would keep one half of our money in the money market account earning 0.75% and put the other half of the money into a 6 month CD earning 1.00%.

  • Money Market – $23,568.06 @ 0.75% = $176.76
  • 6 Month CD – $23,568.06 @ 1.00% = $235.68

Total Annual Return = $412.44

Overall, this strategy would earn $58.92 more per year compared to keeping everything in a money market account. Once the 6 month CD expired, we could reinvest it into another 6 month CD.

We would also have access to half of our emergency fund every 6 months.

12 Month CD Ladder

Another option would be to build a 12 month CD ladder split into 3 equal investments. So $15,000+ would be invested across 3 different accounts – a money market earning 0.75%, 6 month CD earning 1.00%, and a 12 month CD earning 1.25%.

  • Money Market – $15,712.04 @ 0.75% = $117.84
  • 6 Month CD – $15,712.04 @ 1.00% = $157.12
  • 12 Month CD – $15,712.04 @ 1.25% = $196.40

Total Annual Return = $471.36

This option would earn $117.84 more per year compared to keeping everything in a money market account. On the downside, we would only have access to about 3 months worth of of our spending at any given time. I am sure we could deal with making additional sacrifices to make this work in the case of an emergency. But is it really worth an extra $117.84?

18 Month CD Ladder

Building a 18 month CD ladder split equally across 4 different accounts would be the next option to consider. Over $11,000+ would be split equally across the following 4 accounts – money market earning 0.75%, 6 month CD earning 1.00%, 12 month CD earning 1.25%, and a 18 month CD earning 1.25%.

  • Money Market – $11,784.03 @ 0.75% = $88.38
  • 6 Month CD – $11,784.03 @ 1.00% = $117.84
  • 12 Month CD – $11,784.03 @ 1.25% = $147.30
  • 18 Month CD – $11,784.03 @ 1.25% = $147.30

Total Annual Return = $500.82

Building an 18 month CD ladder would earn $147.30 more per year compared to keeping everything in a money market account. This would give us access to 2.3 months worth of our spending at any given time. I don’t like this option as much … especially since it only means an extra ~$150 in our pockets.

24 Month CD Ladder

The final option we would consider is building a 24 month CD ladder split equally across 5 different accounts. Just over $9,000 would be split equally across the following 5 accounts – money market earning 0.75%, 6 month CD earning 1.00%, 12 month CD earning 1.25%, 18 month CD earning 1.25%, and a 24 month CD earning 1.50%.

  • Money Market – $9,427.22 @ .75% = $70.70
  • 6 Month CD – $9,427.22 @ 1.00% = $94.27
  • 12 Month CD – $9,427.22 @ 1.25% = $117.84
  • 18 Month CD – $9,427.22 @ 1.25% = $117.84
  • 24 Month CD – $9,427.22 @ 1.50% = $141.41

Total Annual Return = $542.07

This 24 month CD ladder would earn $188.54 more per year compared to keeping our investments in a money market account. This would give us access to about 1.9 months of our current spending at any given time. Again, not sure the extra increase is worth having the money tied up longer.

Is There a Better Option?

There may actually be a better option for earning a return on our investment. But it is riskier and it goes against what a true emergency fund should be setup for.

We could take our emergency fund and start investing it into dividend paying stocks.

The potential for return is way higher, but our investment dollars are not guaranteed at that point. For example, let’s assume we take the entire emergency fund and invest it in a a collection of top dividend stocks that are (on average) yielding a 2.5% dividend.

With a 2.5% yield, that kind of investment has the potential to earn $1,178.40 in dividend income annually. Wow … that is $824.88 more than we are currently earning!

Total Annual Return w/2.5% yield = $1,178.40

If we were to invest in stocks that earned an average 3.0% yield, we could earn $1,414.08 in dividend income annually. That is $1,060.56 more than we are currently earning.

Total Annual Return w/3.0% yield = $1,414.08

Taking it a step further, investing in stocks with an average 3.5% yield, we could earn $1,649.76 in dividend income annually. That is an extra $1,296.24 compared to our current return.

Total Annual Return w/3.5% yield = $1,649.76

Finally, if we got really aggressive and invested in stocks with an average 4.0% yield, we could earn $1,885.44 in dividend income annually. That is $1,531.92 more than we currently earn!

Total Annual Return w/4.0% yield = $1,885.44

What Should We Do?

Each of the options I have laid out above have pros and cons. I really like the concept of taking our emergency fund and maximizing the returns by investing in dividend stocks. However, I don’t want to compromise our emergency fund … especially if we see the stock market start to drop. But … if we invest in top dividend paying stocks, then we also take most of the risk out of dividend cuts.

Since the stock market is on a roll right now, I think we will probably take a cautious approach to our emergency fund. I would like to have cash available to buy bargains if we get any type of market correction.

So I think we will start by building our 6 month CD ladder. This will give us an extra $58.92 in interest per year compared to our current plan. We will also have 6 months worth of expenses readily available if we need them in an emergency. And … we will have over $23,000+ ready on the sidelines to invest in dividend stocks … in case there is any market correction.

Not necessarily the most lucrative option … but one that has low risk and a bit of an increase in return.

What would you do with an emergency fund in this situation? Invest and get a higher return or keep it in low risk, low return accounts? How do you invest your emergency fund?

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Financial Panther - October 17, 2017

So, my emergency fund has been earning 5% for the last two years without any issue. I’d say it takes less work than setting up the CD ladder for sure.

I’ve written extensively about them, but pretty much, you open up certain prepaid debit cards, all of which happen to come with 5% interest FDIC insured savings accounts attached to them. Depending on how many you open, it’s possible to get as much as $50k earning 5% guaranteed interest.

Obviously, it takes a little bit of work to set up, but once you’ve done that, the accounts run themselves!

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Anonymous - October 17, 2017

Have you considered a high-yield savings account? My emergency fund sits in Ally bank earning 1.2% interest.

You could also lower the amount in your emergency fund (to 3 – 6 months of expenses) and put the rest in dividends.

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    John - October 18, 2017

    @Anonymous – Yes, I have considered high yield savings. I will probably try and invest about 1/2 our emergency fund now in dividend stocks and split up the remainder in a couple CD’s. We probably don’t need a full years worth of spending in our emergency fund.

    Thanks for sharing your thoughts!

    Reply

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