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 The Roth is unique, in that any contributions you make to a Roth can be withdrawn without penalty or taxes.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.
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