Alternatives to the Emergency and Sinking Fund

Safe, high-interest, emergency fund alternatives. Invest your short-term money in liquid and guaranteed accounts. #emergencyfund #daveramsey #workingcapital #sinkingfundOne of the most common pieces of financial wisdom is to have an emergency fund. Dave Ramsey lists it as his first Baby Step. 

Businesses have from the beginning of time required working capital to function as a successful enterprise. 

Investment property owners have maintenance accounts and all these groups frequently employee a sinking fund. (A sinking fund is an account segregated for use in replacing a wasting asset such as a car. The maintenance account many landlords keep is really a sinking fund for eventual required expenditures like a new roof or furnace.) 

There is a reason the emergency fund — and her close cousins the sinking fund, maintenance account and working capital account — is such a widely held belief. Without the capital needed for extraordinary expenses you risk financial hardship when a large expense arises.

There is another advantage to having these accounts: avoiding the need to borrow at an unexpected times. Business owners understand the advantage of having adequate working capital. They also understand that a financial cushion is more than just a convenience in business. Adequate working capital can remove or eliminate the need to borrow under extreme situations.

The best part of an emergency fund is that you get paid a token amount of interest as you wait for the inevitable versus paying interest because you didn’t plan accordingly. This affects profits.

 

Good Advice

As good as the advice is to keep a cash cushion for irregular large expenses, one question is rarely answered: Where do you store the money?

For micro-sized accounts most people employee a simple bank account or keep the money in a sock drawer. This creates a set of new problems.

Banks (and credit unions more and more often) don’t look kindly at small accounts. They act as if an account in their computer with $867.12 in it is creating a massive financial burden to their financial institution. Accordingly, they pay almost nothing (sometimes even nothing) in interest to these accounts. Worse, they may charge fees just for having the account! 

That forces some people to use the sock drawer. The sock drawer has even more problems. With the money so close at hand it is easier to spend, destroying the best laid plans of. . .  ah, you know. If you and everyone in your household has the fortitude to keep their paws off the stash one problem remains: theft. Keeping your emergency fund in cash risks theft or loss in a fire.

And that is where the story usually ends. The advice — keep an emergency fund — is wonderful advice if you were provided options beyond “keep it in the bank or under the mattress.”

 

Options for Storing your Emergency Funds

What other options are available to store short-term money? The bank is okay when you’re first starting out, but once the balance grows even a little it would be nice if your emergency funds pulled its own weight by earning at least a token amount to mitigate the affects of inflation.

There are actually a large number of tools available for investing your emergency fund, working capital, sinking fund and maintenance account that pay you for saving your money there.

Before we discuss the alternatives we need to set some guidelines on what characteristics our alternatives must have.

  1.  The investment must be liquid.
  2.  The investment must be easily accessible within a few days or sooner. We don’t want the money too easy to access as it might allow temptation to creep in, but not so far away we can’t get it when needed.
  3.  The investment must be safe. Guaranteed accounts are nice, but not required. Still, safety of capital is always the highest priority in such accounts.
  4.  The investment must have a return (reasonable interest rate).
  5.  Should be easy to set up.
  6.  The investment should have low or no minimum balance requirements.
  7.  The investment must have the option to make regular additions in small amounts.

 

 Alternative Emergency Fund Accounts

Following the rules outlined above, here is a list of alternative investments for storing your emergency funds and similar monies:

Treasury Direct

A decade ago this was my go-to account for working capital in my tax practice. I couldn’t get a higher safe return anywhere else. That has changed, but is now swinging back onto the radar. 

When the Fed lowered interest rates to zero it was hard to justify using Treasury Direct. However, with short-term Treasuries now sporting over 2% it might be an alternative worth exploring. 

Treasuries are the safest investment on the planet. Not many investments can say they are guaranteed. Treasury securities, some insurance and bank products are the only investments that can claim they are “guaranteed”. And U.S banks and insurance companies are insured by the government so it’s back to Treasuries providing the only real guarantee out there.

The U.S. government has put considerable effort into providing a powerful cash management tool. Let’s run down a few of the options available from Treasury Direct:

There is no reason you shouldn't earn high interest in your emergency fund. Review the alternatives to using banks only. Your #sinkingfund, #emergencyfund, #workingcapital and #maintenanceaccount can pay you while it protects you.Savings Bonds

You can buy Series EE and I savings bonds on Treasury Direct. The Series EE bonds are a poor investment only paying .1%. Maybe they think they are a bank. (All references to yield are from the day of publication: May 5, 2019. Use links to review current yields on investments discussed in this post.) 

Series I savings bonds are a different story, however, paying 1.9%. The Series I is an inflation adjusted bond. If inflation picks up, your interest rate increases. (And declines if inflation declines.)

The best part is you can invest with as little as $25 and increase your investment by any amount above that. 

There are no fees for using Treasury Direct or buying and selling on Treasury Direct.

Treasury Bills, Bonds and Notes

We should differentiate between these types of Treasury instruments before continuing:

  1. Treasury Bills are very short-term instruments with a one-year or shorter maturity. Since we are discussing emergency funds, this may be the most appropriate use for the accounts we are discussing. Bills are sold at a discount and pay in full at maturity. (Example: a Treasury bill with a one-year maturity and slightly more than a 2% return will sell for $980 and pay out the full $1,000 at maturity, which includes the interest.)
  2. Treasury Notes have a 2 – 10 years maturity date from issuance. Landlords with maintenance accounts may find Treasury notes a powerful tool in planning for long-dated maintenance and improvements. Example: a roof with 10 years of life left can be slowly funded first with Treasury notes and finally with T-bills. The interest on the notes will pay out every six months and can be reinvested. 
  3. Treasury Bonds have a maturity date in excess of 10 years from the issuance date. While these long-dated instruments are excellent tools for many investment goals, the T-bond is not the most appropriate tool for emergency funds or working capital. (And also carry the greatest risk of loss if you need to sell the bond prior to maturity. If interest rates climb, long-dated bonds decline in value. They pay in full at maturity, but selling prior to maturity does not guarantee a gain.)

For our discussion Treasury bills will be the most used. T-bills can have a maturity date as short as a few days. You can keep rolling the investment for as long as you want. Your money is only a few days from maturity and easy access at any time.

You can also ladder your emergency fund or maintenance account. I used T-bills in the past to manage working capital in my firm. High revenue in spring was invested with some maturing rapidly and some maturing later in the year when revenue was low and year-end expenses climbed. This allowed for a maximum return on my liquid funds.

T-notes and T-bonds also have low entry points, being purchased in $100 increments with $100 as the minimum.

 

There is one last Treasury to consider: TIPS (Treasury Inflation-Protected Securities). As the name indicates, these Treasuries provide protection from increasing inflation. As inflation (not to be confused with interest rate changes) changes, so do TIPS. TIPS pay a set interest rate for the life of the bond, but the bond increases in value by the recent inflation rate (they are guaranteed to never decline if there is deflation). This means your interest earned keeps climbing as the value of your bond grows over time. At maturity TIPS pay out the entire inflated value of the bond. (Note: Interest paid out and inflation increases accrued to the bond’s value are all currently reported interest income for tax purposes.)

TIPS come in 5, 10 and 30 year maturities and pay out interest every six months.

Money-Market Accounts

It wasn’t long ago when money market accounts paid about what banks did: nothing. With the Fed Funds rate at 2.5% things have changed. 

I use Vanguard’s Prime Money Market Fund for personal and business cash management needs currently. It is easy to use and funds are always accessible. The rate as of this writing is 2.47% compounded annually. 

The biggest issue for some people is the $3,000 minimum to start. (I allowed my account to drop below $3,000 after opening without issue.) You can add and withdraw almost any amount at any time once you meet the minimum to open the account.

If your emergency fund is really small Treasury Direct might be the best option. For everyone else, the ease of using Vanguard trumps the very, very small interest increase from using Treasury Direct.

Capital One 360, Discover Savings and Similar Accounts

For a while Capital One 360 and Discover Savings paid better than just about anything else. Now Vanguard’s Prime MM Fund is better. 

Keep these options in the back of your mind in case things change (and they always do). 

There are several additional similar style accounts. I’ve noticed several advertise on this blog whenever I discuss such topics. Always do your due diligence before committing. The highest rate only makes sense if it serves your needs safely.

 

Thinking Outside the Box Options

Back in the old days there was a guy called Charles Givens. He was the financial guru circa 1990. (I have an autographed book of his on my bookshelf.) One of his claims to fame was to reduce your insurance to save money and use credit cards if you had a loss. He was sued for that advice according to Wikipedia and a certain accountant’s memory.

Maximize the interest earned in your working capital account and emergency fund. #emergencyfund #workingcapital #interestAs bad as the advice was, it still had a kernel of truth behind it. Over-insuring is expensive and damaging to your wealth. Having a high deductible on your car insurance is worth considering. Credit cards today have cash-back rewards and bonuses. Properly structured, some readers may find value in the old strategy.  

As much fun as this strategy sounds, I’m not the biggest fan of using credit cards as your emergency fund. It just sends a shiver up my spine. I would rather use sound financial principles to reduce and eliminate debt.

But this does bring up another outside-the-box idea to maximize your emergency fund returns.

This idea only works if you have debt and you own your home. The goal is to reduce debt whenever possible.

Instead of having an emergency fund (working capital account, maintenance fund, sinking fund, et cetera), plow the amount destined for the emergency fund into paying down your mortgage. When you need the funds back, use a line of credit (HELOC).

Let me illustrate:

You start with a mortgage of $100,000 (or whatever amount your situation dictates). You plow emergency fund and similar monies into reducing your mortgage.

You open a home equity line of credit so the money is available when or if needed. If you draw from the HELOC you now divert your regular emergency fund investments from paying off the mortgage faster to paying off the HELOC.

Since your mortgage and HELOC probably have a higher interest rate than the options I listed above you are better off using your debt as a tool to reduce your debt faster. 

Of course, this all assumes you qualify for a HELOC and is based on your mortgage and HELOC interest rates. You also want to consider the HELOC rate further. If the rate is lower than your regular mortgage you might want to move some of the regular mortgage to the HELOC to benefit from the lower interest, depositing emergency fund money to the HELOC, freeing credit limit for emergency uses.

Caveat: HELOC interest rates float. This means the interest rate can change from month to month. The HELOC is not the replacement for the traditional mortgage.

 

Coda

There are choices outside of banks for storing your short-term capital. It doesn’t always have to be an emergency fund either. Keeping some powder dry for an investment opportunity is a smart move. Getting something while you wait isn’t bad either.

 

 

More Wealth Building Resources

Credit Cards can be a powerful money management tool when used correctly. Use this link to find a listing of the best credit card offers. You can expand your search to maximize cash and travel rewards.

Personal Capital is an incredible tool to manage all your investments in one place. You can watch your net worth grow as you reach toward financial independence and beyond. Did I mention Personal Capital is free?

Side Hustle Selling tradelines yields a high return compared to time invested, as much as $1,000 per hour. The tradeline company I use is Tradeline Supply Company. Let Darren know you are from The Wealthy Accountant. Call 888-844-8910, email Darren@TradelineSupply.com or read my review.

Medi-Share is a low cost way to manage health care costs. As health insurance premiums continue to sky rocket, there is an alternative preserving the wealth of families all over America. Here is my review of Medi-Share and additional resources to bring health care under control in your household.

QuickBooks is a daily part of life in my office. Managing a business requires accurate books without wasting time. QuickBooks is an excellent tool for managing your business, rental properties, side hustle and personal finances.

cost segregation study can reduce taxes $100,000 for income property owners. Here is my review of how cost segregation studies work and how to get one yourself.

Worthy Financial offers a flat 5% on their investment. You can read my review here. 

Keith Taxguy

21 Comments

  1. Evan on May 5, 2019 at 11:19 pm

    Interesting article Keith and great timing! I was just researching this very topic, trying to think of a better way to earn higher interest on my emergency fund. I recently read another article on earning 5% on savings accounts linked to a prepaid debt card through Netspend. Here is the web address to that article: https://financialpanther.com/netspend-account/. I know typically prepaid debt cards are a bad product with high fees associated with them and are designed to prey on those unable to gain access to traditional banking. However, this strategy is meant to only use the savings account and not the debit card. The brief summary to setting this up is each individual can open a series of 5 prepaid debit accounts and place up to $1,000 in each of the linked 5% interest savings accounts. This means that an individual could earn 5% on up to $5,000 and a married couple up to $10,000. I’d be curious to know if you’ve heard of this and if you had any thoughts before taking the plunge to employ such a strategy?

    • Katy on May 6, 2019 at 10:24 am

      Well the ask was for creative and still secure solutions. A lot of people go through more hassle setting up bank bonus churning schemes. Would you periodically harvest the gains so that they would be earning more interest in a HYSA? To clarify, over $1000 they earn .5% so you don’t want more than $1000 there, every time interest drops instead of compounding to get increasing gains you are earning less on those dollars. (I haven’t calculated the break even point where the APY would match, I’ll leave that to smarter minds.) Use case: deposit until balance reaches $1000, then every month when interest income hits xfer that amount to another savings account with a higher yield (either a new netspend which would probably be ideal if it could be done for no fees, or to a HYSA or Vanguard MM).

      I may just look into it for a small value savings account that my toddler has where we put his “allowance” and birthday/Christmas money over the next decade of his life even at a small amount that extra 2.8% interest could make a difference.

      • Evan on May 6, 2019 at 10:49 am

        Yes I believe the intent of this strategy would be to only maintain up to the $1,000 balance in each of the accounts which earns the 5%. There is obviously a cap to using this strategy in order to earn the 5%. Then periodically withdrawing the earnings and transferring into some other high yield savings account as you mentioned. I think the author of this article uses an online Ally checking and savings account which currently yields 2.2%. I have not done this myself and cannot speak from experience, but my understanding of an online account such as with Ally vs most traditional brick and mortar banking methods is the ease of transfers and unlimited accounts that can be linked and money moved between without additional fees. My current traditional banking institutions would be cost prohibitive to use as they apply ACH transfer fees every time you want to move any money.

  2. Cathleen cooks stuff on May 6, 2019 at 1:21 am

    I’ve got some money floating in the vanguard mm, haven’t checked on the apu recently, so might do so. We have a chunk of change waiting in our savings account for if we buy a new home. It might now be a better idea to transfer it over to the mm. Though I don’t believe those are FDIC insured, are they?
    On the HELOC side, in hawaii some of the local banks are offering helocs with fixed APRICE for a few years. The ,ore years the higher the %. All the way up to 25 years fixed! Is this a deal I’m missing out on? 2.25% fixed for 2 years, up to 4.75% for 25 years. Not too bad, but the 25 year rate is a bit higher than my current mortgage.

  3. FiPhysician on May 6, 2019 at 2:02 am

    Another outside the box suggestion: you can use a Roth or backdoor Roth as an emergency fund ( https://www.fiphysician.com/can-you-get-your-money-out-of-a-backdoor-roth-contribution/ ).

    Of course you would want additional emergency funds slightly more accessible, but you can withdrawal your contributions to a Roth or backdoor Roth tax and penalty free. Invest in ultra-short term bond funds or whatever you wish to keep the principal protected.

  4. Gino on May 6, 2019 at 7:13 am

    Keith,

    Great article and how timely for my wife and I. I have money sitting in the Vanguard Prime Money Market you mentioned and have the following dilemma.

    We just purchased a truck this week, and I have really been beating myself up over it! Because I’m not use to spending large amounts of money even though we could easily afford this purchase.

    After four months of looking, I found the used truck I wanted with only 20K miles in pristine condition. One owner, like new.

    I took out a loan at 3.49% with PenFed.

    My gut tells me to keep my money invested. And not to prepay the loan or pay it off.

    After front loading our retirement accounts by June, I’ll have about five to six thousand dollars per month in discretionary income that I could put towards the loan or I could invest that money into VTSAX.

    Even if and when the market corrects during the time I’m making payments, I just look at it as shares that I am buying on sale.

    I feel that [b]over the long term[/b], ten plus years, the additional money will be better served invested for growth and not tied up in a car.

    I would like to know your opinion and those of others, on what you would do if you were in my position. I’d like to know from a financial perspective and not an emotional one what you think in your opinion the optimal course of action is. Thanks for any and all feedback!

    A. Pay off the loan
    B. Make extra 5k to 6k monthly payments or
    C. Make the regular monthly payment and invest the rest

    Thanks!
    Gino

    • Planedoc on May 6, 2019 at 8:52 am

      Vino, just one guys opinion…(and I love trucks…have 2 of em)…be cautious buying something that plummets in value.

      I buy old used ones. And…i pay cash.

      Essentially…you are borrowing money to invest. It works great…up until it doesn’t.

  5. Planedoc on May 6, 2019 at 8:48 am

    Keith nice summary.

    I had recently looked at this and decided to do T-bills and VMMXX. Thank you for confirming my decisions!

    I’d love to see your thoughts on when to drop life and disability insurance…..

    • Gino on May 6, 2019 at 9:22 am

      Thanks Plane Doc,

      I bought it used and we keep them for about ten years. My daughter totaled my last one, not her fault and thankfully she’s ok!

      So I was forced back in the market. My gut is telling me invest the extra money. Thanks for the feedback.

  6. Planedoc on May 6, 2019 at 8:53 am

    Sorry..autocorrect…Gino…won’t let me edit

  7. Michele on May 6, 2019 at 9:16 am

    Get article! Definitely gave me something to think about! Sent this to my fiance’ to read as well. We are trying to get better with our money and its good to know we have many options.

  8. Kristen on May 6, 2019 at 9:44 am

    Good article! I was trying to play around with bank account churning to get better returns off the emergency fund, but it’s a pain. I didn’t know about VMMXX, so that’s going to make my life a helluva lot easier.

  9. Jason on May 6, 2019 at 10:41 am

    I previously had a sizable emergency fund of $20k or so in an online bank. However, only generating 2% interest leaves a sour taste in my mouth. As such, I began to transfer a little at a time into index funds. I wait throughout the year for a bear market, then max out a Roth (a taxable brokerage would work as well if you are already maxing a Roth). Should the market tank during that time, I would still have the savings account to draw from if needed. However, over the four year period, the gains realized by the initial investment will more than make up for a 30% dip. After that, the longer I go without needing the emergency fund, the better off this strategy works out to be.

    The important thing is to do it a little at a time.

    • Katy on May 6, 2019 at 11:13 am

      That’s a strategy I’m interested in, especially for a “sinking” fund for a car, rental purchase, or home renovation as I would likely have some control over the timing, cost, and have alternative options for funding if necessary.

      So many people would see that 30% dip and feel like they made the wrong choice but not do the math and realize they were still 5% better off in the long run.

  10. Michael on May 6, 2019 at 1:46 pm

    Hello! What’s the best way to see what the current yields are for each investment vehicle. I registered an account and it’s not the most user friendly website. Any help is most appreciated.

  11. Ashish on May 9, 2019 at 9:13 pm

    I keep mine in American express HIGH YIELD SAVINGS ACCOUNT which (as of now) gives 2.1% and is FDIC insured.

    Does the value of VMMXX tank if the stock market crashes?

  12. Craig on May 12, 2019 at 6:41 am

    this is off topic! Can one open a roth after retirement with 401k funds?

    • Katy on May 14, 2019 at 8:27 am

      Only up to the amount of earned income you (or your spouse?) has.

  13. Katie Camel on May 14, 2019 at 9:29 am

    I’ve been a long-time user of Capital One 360/ING Direct as my overall bank and holder for my emergency fund, but lately I’ve been looking around at higher earning options. Call me lazy, but I like the convenience of Capital One’s option for various savings account within one account, so I can divide my savings into different envelopes, so to speak. But I’m also a long-time Vanguard holder and had their MM at one point. Part of me is considering it again for my EF. Mostly, though, I wish I could get those thousands of dollars to earn more than 1-2% interest. In the meantime, I’ve been doing bank account churning to get the bonuses.

  14. Jarred on June 11, 2019 at 12:04 pm

    Keith,

    Thanks for this post. I’ve recently converted my business from a sole proprietorship to an S-Corp. I’ve been looking for a place to hold my business cash and like the ideas you’ve laid out here. My question is do you have separate business and personal accounts at Vanguard? Does Vanguard allow business accounts?

    • Keith Taxguy on June 11, 2019 at 12:24 pm

      Separate accounts. You’ll have to ask Vanguard what they allow for business accounts. They should have no problem with business accountants, at least I had no problem.

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