By: Michael Allbee, CFP®, Senior Portfolio Manager
Volatility or down markets only become a problem if you’re forced to liquidate at the wrong time. If you have enough cash to get you through, you’re going to come out fine on the other side most of the time. We generally recommend setting aside funds to cover 3-6 months’ (6-12 months’ if retired) worth of non-discretionary living expenses (i.e., housing, taxes, debt service, groceries referred to as needs) as an emergency reserve. This recommendation helps our clients handle short-term problems that are beyond their control (i.e., unemployment, car problems, medical bills, etc.). Without an emergency fund most people resort to using high-interest rate credit cards to pay their expenses. This conflicts with your long-term goal of saving for retirement and/or portfolio withdrawals at an inopportune time.
We also recommend matching the time horizon for when you may need the money with the chosen savings product. For example, we recommend keeping some of your emergency reserve in a FDIC-insured savings account at your bank, an online bank, or credit union that offer daily liquidity. What you earn on your emergency reserve is irrelevant and the main goal of this investment is liquidity. However, one positive of the current increase in yields, is that many of these FDIC-insured savings accounts now offer yields up to 0.90% today. Recently, we have been working with clients to purchase 3-month to 2-year Treasury bills yielding between 1.7% – 3.2% for a portion of their emergency reserves or for other short- and medium-term savings goals, such as a down payment for a house or car purchase. These yields are higher than current Certificate of Deposit (CD) rates and are principal protected if held to maturity.
If you have excess reserves that you won’t need for at least 12-months (and preferably 5 years), we have been recommending Series I savings bonds (I Bonds). I Bonds are currently yielding 9.62% and can be bought directly from the Treasury Direct website. Unfortunately, each person is limited to purchasing $10,000 worth of I Bonds a year, and the yields will fluctuate based on inflation. Furthermore, if you cash in your I Bonds within five years of purchasing them, you lose the previous 3 months of interest.
Another consideration is a Roth IRA. The Roth is unique, in that any contributions you make to a Roth can be withdrawn without penalty or taxes. The caveat is that any earnings in the account need to remain for five years, and you must be 59.5 years old or older (unless an exception applies) for it to be considered a qualified distribution to avoid taxes and a 10% penalty. In turn, you are technically saving for retirement and building a nest egg for any short-term unexpected expenses. This option should be looked at as an additional cushion to your emergency reserve and not as a replacement, since the funds in your Roth account should be invested in the markets which will fluctuate in value.
We highly encourage you to Talk With Us if you want to strategize about your emergency reserves or need help building your emergency fund.
Disclosure: BFSG does not make any representations or warranties as to the accuracy, timeliness, suitability, completeness, or relevance of any information prepared by any unaffiliated third party, whether linked to BFSG’s website or blog or incorporated herein and takes no responsibility for any such content. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly. Please remember that different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment or investment strategy (including those undertaken or recommended by Company), will be profitable or equal any historical performance level(s). Please see important disclosure information here.
Do you have excess cash reserves that you won’t need for 12-months? If yes, then consider Series I savings bonds. These bonds pay a fixed rate for the life of the bond (today it is 0%), plus the annualized Consumer Price Index (CPI) inflation rate. With the interest compounded semiannually, these I Bonds will pay a total annualized interest rate of 7.12% through April 2022, well in excess of any other safe yield obtainable (*see below on liquidity constraints). If inflation rises, the rate will go up when it resets in April. The bonds also protect against deflation: the overall rate on the bonds can never fall below zero. A win-win scenario.
In addition, the interest on an I Bond is exempt from state and local income taxes, and if you use the proceeds for qualified higher-education expenses, the interest is exempt from federal taxes as well (*income restrictions apply). Interest is deferred until the bond matures or is cashed in and you don’t pay federal taxes until you redeem the bond.
Maturity takes 30 years, and you must hold a Series I bond for 12 months, but you can cash them in after one year with a small penalty and after five years without any penalty.
You can buy up to $10,000 per person per year directly from Treasury Direct. Couples can use a year-end strategy to bring their holdings to $40,000, with each spouse buying $10,000 in December and another $10,000 in January. Another $5,000 in I Bonds can be purchased with an income-tax refund.
Disclosure: BFSG does not make any representations or warranties as to the accuracy, timeliness, suitability, completeness, or relevance of any information prepared by any unaffiliated third party, whether linked to BFSG’s website or blog or incorporated herein and takes no responsibility for any such content. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly. Please see important disclosure information here.