Earning a Bit More in Our Emergency Fund

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It’s been about 1 year since I last discussed our family’s emergency fund … and the best way to earn income from that money.

Based on our current spending (around $60,000 per year), my family has enough money in our emergency fund ($40,000) to cover 8 full months of expenses.

If we were to cut out all non-essential spending, we would likely be able to survive on those funds for 12 months or a bit longer.

Hopefully we don’t ever need to rely on these funds … but you really don’t know.

How to Optimize Your Emergency Fund for More Income

Emergency Funds

When I last wrote about what to do with our emergency fund money (last year), we had around $47,000. This year, we have just over $40,000.

So why the $7,000 drop?

My youngest son got braces last spring. And while it wasn’t an emergency, we decided to give ourselves a loan to pay for the braces outright. Our insurance doesn’t cover braces unfortunately.

So we ended up giving ourselves an interest free loan from our emergency fund of $7,000. About $6,100 was for the braces and another $900 for some other expenses we had at the time.

The net result is that we saved (and earned) the equivalent of about $1,000 by doing this.

And for the past 6+ months we have been making monthly payments (around $240) back into one of our investment accounts. Our goal is to pay ourselves back in 30 months.

This time instead of investing the money back into our emergency fund, we are using those dollars to invest in our Roth IRA accounts.

We figured that was a good way to optimize future taxes and still have enough funds ($40,000) to support our lifestyle in an emergency.

How to Earn Income From Your Emergency Fund

With such a large sum of money set aside in our emergency fund … we want to make sure it is working hard for us earning more income.

At the same time, we don’t want to put it in any risky short-term investments. The goal is to have this money available in case we need it in a pinch.

We also want to have quick access to these funds. Tying up our funds long term is not really a good idea for an emergency fund.

So what are the options for investing our emergency fund into low risk accounts where we can easily access our money? And maximize the dollars we can earn at the same time?

One option we have used in the past, was to build a CD ladder.

If you need an overview on CD ladders, here is a quick explanation on how to build one.

How to Build a CD Ladder

A CD ladder is a way of investing in multiple CDs (aka 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.

Intervals between each of the certificate of deposit accounts should be at equal lengths. For example, you could have 6 months in between each, 12 months in between each, 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.

Should We Build a New CD Ladder from Emergency Funds?

Last year when I analyzed building a CD ladder, we would have earned between $412 to $542 dollars in interest … depending on the type we built.

We actually didn’t take any action and left our funds in a money market account earning 0.75% interest.

That isn’t horrible (compared to a checking account) … but we didn’t optimize our earning potential.

Our total return just from doing nothing still brought in $350+ of interest income.

Now one year later, we decided to take another look at optimizing our emergency fund dollars. Interest rates (and CD rates) are starting to rise.

So does it make sense to build a CD ladder?

Below is a scenario where we are considering building a 6 month CD ladder with our $40,000.

We would have $8,000 available at all times to easily access. And every 6 months another $8,000 available (along with any interest).

The First 6 Months

The CD ladder that we are now considering would look like the following for the first 6 months of the year.

Note – The following rates used were at a point in time (October 2018) from our credit union.

  • Money Market – $8,000.00 @ .75% = $30.00
  • 6 month CD – $8,000.00 @ 1.65% = $66.00
  • 12 month CD – $8,000.00 @ 1.80% = $72.00
  • 18 month CD – $8,000.00 @ 1.85% = $74.00
  • 24 month CD – $8,000.00 @ 2.05% = $82.00

After the first 6 months of this CD ladder, we would have earned approximately – 324.00!

That is only about $25 less than we earned on our emergency fund the entire 12 months last year (and with $7,000 less to invest). Unfortunately we didn’t take action last year and let our emergency funds sit idle earning 0.75%.

So after the first 6 months of the year, our 6 month CD would expire, which means it would be time to start the next piece of the ladder.

The Second 6 Months

Once the first 6 month CD expires, we immediately take those funds and reinvest them into a new 24 month CD to keep the ladder working.

A hypothetical scenario could look something like this –

  • Money Market – $8,000.00 @ .75% = $30.00
  • 12 month CD (6 months till expiration) – $8,000.00 @ 1.80% = $72.00
  • 18 month CD (12 months till expiration) – $8,000.00 @ 1.85% = $74.00
  • 24 month CD (18 months till expiration) – $8,000.00 @ 2.05% = $82.00
  • 24 month CD (24 months till expiration) – $8,000.00 @ 2.05% = $82.00

After the second 6 months of this CD ladder, we would have earned approximately – $340 during that time frame.

Note – At this point, all CD rates would be locked in except for the new 24 month CD. We are just assuming rates won’t change between now and then in our calculation. If rates do change, our total return could be slightly higher or slightly lower.

12 Month Total Return

In this “what-if” scenario, we could potentially earn $664.00 from our emergency fund.

That is a 1.66% return on a $40,000 investment into a CD ladder.

12 Month Return – $664.00

Compared to last year, we only earned $351.63 on more money ($47,000+). This was because we took no action last year and let our money sit idle, earning 0.75%.

So if we were to take action this year in a low-risk investment … we would more than double our earnings potential.

Alternatives to Building a CD Ladder?

As we have calculated, building a low-risk CD ladder could be a good option to earn more income from our emergency fund.

But are there even better options out there?

With the recent rise in interest rates, it seems like there may be another really good option – on-line savings accounts.

On-line Savings Accounts?

One promising alternative to building a CD ladder with our emergency fund is opening up an Ally bank savings account.

Currently, the on-line bank is paying 1.90% APY on any amount.

So taking our $40,000 and investing it into one of these savings accounts would earn us $760 in interest this coming year.

Annual Savings Account Return – $760.00

That is certainly a very promising return and something we need to consider.

The one downside is that we are trying to move away from opening new financial accounts. In fact … we are in the process of consolidating them to simplify our finances.

We currently have our emergency fund through our credit union … and would like to keep an account open with them.

But the extremely low risk option of earning $760 per year on our emergency fund is very appealing.

Plus, the funds would be available at any time if we needed them. There is no minimum investment or balance amount with this type of savings account.

Investing in Stocks?

Another option is to take our emergency fund dollars and invest them in quality dividend paying stocks.

If we would have done that last year … I can almost guarantee a huge return on that investment based on what the market has done.

But before getting carried away … I need to step back and think about the intent of these funds.

The funds are for an emergency … so we may need them next month. Or in another year or in 5 years. There is also a chance we may actually never need our emergency funds. We just really don’t know?

Investing our money in a top dividend stock paying a 2.5% dividend yield would generate an extra $1,000 of income.

Hypothetical Annual Dividend Income = $1,000

That is very tempting for sure!

At the end of the day … investing in quality dividend stocks is a great long-term strategy.

But investing money we need in the short term … dividend stocks are probably not the best option.

How Should We Invest Our Emergency Fund?

I’ve highlighted 3 decent options on how we could invest our emergency fund dollars over the next year.

Of course, we could do nothing again and earn 0.75% … which is a $300 return. That is the lazy way to earn income from our emergency fund.

We could also build a CD ladder and more than double our income by earning around 1.66%. That would bring in around $644 of extra cash next year.

Or if we were really smart and wanted a simple way to earn more income … we can open up an on-line savings account through Ally bank. The current 1.90% rate would earn an extra $760 of income.

Finally, if we took a bit of a risk … we could really amp up our income by investing our money into dividend paying stocks. The only issue is if/when the market corrects … we may lose out in the short term of having all our assets available to use.

So what is our decision?

I think we will probably go the direction of the on-line savings account. It offers the highest return for the least amount of risk when it comes to an emergency fund.

How would you invest your emergency fund? What type of income are you currently earning from your emergency fund assets?

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