Cash Reserves & Emergency Fund Update: Q1 2012

Having at least six months of expenses provides financial stability, helps you avoid debt with high interest payments, and lowers stress levels. We have a full year of expenses put aside in liquid cash, and it lets me sleep well at night.

Emergency funds can actually have a better return on investment than what you see on a bank account. But that doesn’t mean I shouldn’t still maximize my interest earned, especially as cash is an asset class where you can increase your return without having to take on additional risk (if you stay FDIC-insured or equivalent).

Even though interest rates are low, if you can earn an incremental 1% more over years it becomes significant. I last shared my emergency fund breakdown in the 2nd quarter of 2011, and rates have stayed low since then. Here’s what the overall scene looks like today…

Rewards Checking Accounts

Usually through smaller credit unions with limited membership areas, these checking accounts pay a higher interest rate if you jump through some hoops each month. However, if you make a mistake you’ll forfeit virtually all your interest for that month, so it can be tricky. An example is Consumer’s Credit Union and their Free Rewards Checking account paying 4.09% APY interest on balances up to $10,000 if you make 12 debit card purchases + one billpay per month. The rate is even guaranteed at least through June 30, 2012. You can join with a $5 one-time fee, as noted on their online application.

Find a local rewards checking account by using the filters at the DepositAccounts database. I no longer have any money in any rewards checking account as the benefits are too low for the time and effort of jumping around, especially when I could just do some $250+ credit card bonuses for much more (non-taxable) easy money.

Long-Term CDs – Ally Bank

Ally Bank LogoIf you have a large cushion, it’s quite likely to just sit there for years or more. Therefore, I think it’s okay to put some of it in longer-term investments. With the Ally Bank certificates of deposit, you can still access your money as long as you pay a early withdrawal penalty of 60 days interest. That’s significantly less than at other banks. I have 5-year CDs paying 3% APY, but the current rate for new deposits is 1.60% APY for a 5-year CD (as of 10/25/13). I’ll show you below why this is still a competitive and flexible rate.

Let’s analyze a CD paying 1.74% APY with an early withdrawal penalty of the last 60 days of interest. Here’s how your actual annualized interest rate would fluctuate given your holding period.

After just 6 months, you’ll already be earning 1.15% even after the penalty. If you hold it a year and withdraw, you are already at 1.45% APY. Try to find any similar 6-month or 12-month term CD that beats those rates. Basically after just 6 months I have nothing to lose and a lot to gain, so I keep a sizable chunk here.

U.S. Savings Bonds

For inflation-linked Series I Savings Bonds, the total rate earned consists of a fixed rate and a variable rate that adjusts with inflation every 6 months. Series I bonds bought right now will earn 3.06% for the first six months, and then an unknown rate based on ongoing inflation after that. Even with zero inflation, it will still earn more than any 1-year bank CD… and I really don’t see zero inflation.

My older I-Bonds have been paying off, some of them have a higher fixed rate of about 1%. I was recently earning 4.6-5.6% a six month period. For 2012, the annual purchase limit for electronic U.S. savings bonds bought at TreasuryDirect is now $10,000 per series, per person. You can also get another $5,000 in paper bonds from your 2011 tax return refund using Form 8888.

Online Checking and Savings Accounts

The online savings account world has been a rather boring and dreary place. The classic Capital One 360 is now at 0.75% APY, and other banks are clustered around it. The only mildly exciting thing that has happened is TIAA-CREF has started TIAA Direct with an intro rate of 1.25% APY. But even they admit that’s a promo rate and it could drop any day. It appears far too difficult to separate yourself from the pack for long in this rate environment, otherwise somebody would do it. Alternatively, Everbank has their Yield Pledge Money Market and Interest Checking paying 1.10% APY guaranteed for the first 6 months for new accounts. Since it is fixed, that is better than any other 6-month CD rate out there.

Since I already have my CDs there, I’ve been happy waiting things out with Ally Bank for my daily banking convenience and emergency fund needs. Their Interest Checking currently pays 0.40%-0.75% APY and their Online Savings is at 0.85% APY (as of 11/12/13). I am going with Ally due to their checking features like no fees, ATM fee rebates everywhere (even at ripoff Las Vegas casinos), and free overdraft transfers from savings. This allows me to keep a minimal balance in checking and more in savings/CDs. Check out my Ally Bank Checking account review for an in-depth rundown.

Comments

  1. Based on your previous posts I bought some I Savings Bonds through TreasuryDirect. I have no idea how to calculate the potential interest income after this 6 month period especially if there is no inflation. You seem to indicate in this post that the number will still be something over 1%.
    Can you elaborate a bit?

  2. For those who have a substantial emergency fund it is very important to maximize your return, but sometimes it’s difficult to know exactly what the impact different returns will on your fund over time. I wanted to share this emergency fund analysis template that people can use to help in their allocation assessment. http://www.spreadsheetshoppe.com/emergency-fund-analysis.html

  3. Question:

    I currently have about $3500 in CD’s with Ally and $4000 in Ally Savings. I am aiming for $10K in Savings on top of the $3500 CD’s. This is a double layered Emergency Fund. With the CDs being the Oh $h!t layer and the Savings being my “Need New Tires” layer.

    Would you recommend I start shifting some of thes funds to Savings Bonds? I need limited flexibility with regards to accessing funds. A week to ten days to access funds would be fine.

  4. @ Chris C. About Savings Bonds, they are completely inaccessible for the first year. You have to wait one year before you can redeem them. So that’s an important issue to consider for using savings bonds as an emergency fund.

  5. I would recommend that anyone who is considering extending the maturity of the instruments in which their emergency fund is invested (i.e. the 5-year CDs) to pick up some yield should consider using a ladder rather than just dumping it all into one CD. For a five-year ladder buy a 5-year CD now and after each of the next four years, putting 1/5 of your emergency fund into each. That way if rates move up over time you will capture some of the higher CD yields in future years, rather than locking up all your money at today’s low yields and (possibly) regretting it in a couple of years if rates back up. The other nice feature is that in five years when the thing is up and running you will have 1/5 of your money maturing every year so you can access that for a new roof or vehicle repairs without paying the penalties to get to your funds. Only if you need more will you have to pay the penalty. Otherwise, when that 1/5 matures each year you can buy another 5-year CD. Once set up you will be able to get 5-year interest rates while your money is effectively tied up on average for about 2.5 years. By comparison, if you just put all your money into a 30-month CD you’d get less interest than you get from the ladder.
    Food for thought.

  6. There’s no need to have so many ‘funds’ (emergency, retirement, fun). All you need is one fund and a little self control.

  7. Have you considered the following high checking/savings product? They all beat ally savings of 0.84%.

    TIAA Direct Savings 1.25%
    Alliant Credit Union Savings 1%
    Alliant Credit Union Checking 0.95%
    Incredible Bank Checking 0.93%

  8. All of these options are completely pointless.

    I have $140,000 in my ING Direct savings account at 0.8% and earned less than $100 a month in interest.

    Whoop De Do!

    Why not spread it around in some Blue Chip stocks? ATT pays over 5% dividend. GE pays 3.5%. Coca Cola pays 3%.

    This is why I firmly believe in long-term upside in the stock market because there’s no reason to be hoarding cash when interest rates are this pathetic.

  9. @David – If there is no inflation over the set period from Sept 2011 to March 2012 (announced mid-April), then your 2nd 6 months will indeed be zero. But since your first 6 months was so high, you’re still pretty good. We’ll see if inflation is really zero since then, we still have 2 months of CPI announcements to go.

    @Chris C – No, savings bonds cannot be redeemed for the first 12 months (11 months, if you buy at end of month) so they have poor liquidity in the beginning.

    @Andy – I agree, CD laddering is a good idea.

    @harry – If we all had perfect self control, the world would be a very, very different place. You also can’t just stick all your money in an IRA or 401k “retirement” fund and expect it to be liquid, you have to set it aside in the right place.

    @Nit – I did outline other options, including TIAA at 1.25% variable and Everbank at 1.05% fixed for 6 months.

    @Xtian – Dividend stocks are great, but they aren’t cash. You can believe in the long-term upside of the stock market without devoting ALL your money into them.

  10. I like to use credit union’s where possible, it reduces the amount of money greedy banks get there hands on!

  11. “Find a local rewards checking account by using the filters at the DepositAccounts database. I no longer have any money in any rewards checking account as the benefits are too low for the time and effort of jumping around, especially when I could just do some $250+ credit card bonuses for much more (non-taxable) easy money.”

    I am confused by this statement. If I want to keep a bunch of cash, not invested in mutual funds/stocks, isn’t the best way of earning the most for that using the accounts with the highest APY which seem to be the rewards checking accounts.

    Now I understand the hoops they make one jump through, and how they keep lowering the rates …etc. But I don’t understand why the credit card bonuses help one to replace this as one is not keeping money in credit card accounts. Could one not do both the credit card bonus AND the rewards checking accounts? What am I missing?

  12. Also, should be noted, with Ally CDs you can split your cds into different lump sums since there is no minimum balance, so instead of putting $3500 into one CD in Chris’s case, instead put it into 3 $1000 cds and one $500 cd so this way if he does have to access the money he can redeem only the amount he needs and able to keep the other cds intact so he continues to keep the higher rate and not pay the penalty on the interest of all the cds.

  13. @Jonathon, forgot about that little caveat. I know you had some really thorough posts abotu Savings Bonds. I will have to spend some time reading up on them.

    @Dan, I actually do have my CDs structured into 500 + 800 + 1000 + 1200 this is done for various sized emergencies. =)

    Once I get my savings account up to 10K, I want to start building a 10K CD ladder. These numbers would be considerable higher but I am paying a monsterous amount towards my debt. Between triple and 10x monthly payments, outlined here:
    http://twitter.com/#!/TickInTime/status/177407483625750528

  14. I have purchased I-Bonds over the years which now allows for a very nice emergency fund. In addition, they also provide a solid foundation for a portion of my fixed portfolio. I-Bonds are 100% guaranteed, inflation protected and state tax free. As Jonathan pointed out, I-bonds from 6+ years ago are cleaning up. When the market went down, my I-Bonds kept chugging along.

  15. The 4% rewards checking account is tempting, however the 12 debit transactions a month are annoying. Is there some sort of trick that you can employ to fulfill this requirement?

  16. @Matt, I personally had 6 reward checking accounts recently that required a total of 73 debit transactions per month. I agree its a pain. On all but one of the accounts I satisfied the transaction requirements by going to the grocery store and individually buying packs of koolaid (approx $ 0.13/pack) all at the same time and on the same day. This does two things, it takes the least amount of money from the accounts and it gets all the transactions done at once, so as to not forget. This has been OK, but recently I had half of my accounts lower their rates (down to 2% and 2.25% from 3% in both). To hedge my bet I closed the 3 lowest yielding accounts and opened 7 year CDs at PenFed (at the time, yielding 2.75%). I’ll will be left with reward checking accounts yielding 4%, 3% & 2.5%. So yes reward checking accounts are still viable and necessary if you ask me, but they are increasing becoming less bang for the buck. Hopefully the full-on assault on savers will recede soon. Oh how I long for the days when simple online savings accounts yielded 5%+ just for being there. Best of luck.

  17. I was just reading an article in the WSJ about this earlier today. I have been keeping my cash in various ING accounts, earning roughly a pathetic 0.80% interest. They also mentioned I Bonds and that’s something I’ll have to look into.

    @Xtian — I follow the dividend stock approach to a certain degree. Right now I’m about 50% cash, 50% dividend funds. Sure, stocks are not completely liquid, but if necessary, how long does it take to sell some shares, and have that money transferred to your checking account? Not long. The bigger worry is depreciation of value.

  18. I like your Ally strategy and opened a 5 year CD a few months ago when rates were a little higher. It looks like interest is only paid out once a year. Do they pay you partial interest if you decide to close the CD in the middle of the year? Otherwise you potentially lose out on up to almost a year’s worth of interest plus the 2 month penalty. If that’s the case your graph wouldn’t be as smooth.

  19. @Prateek – Ally Bank will pay accrued interest upon withdrawal.

  20. Dividend stocks have their place but IMHO not in an emergency fund. The entire premise of the emergency fund is to be secure enough to weather a catastrophe such as unexpected job loss or a health/home/auto crisis above insured limits. Even the blue-chippiest dividend stocks lost ~50% of their value to March 2009. Heaven forbid you needed your emergency fund at that point in time, which BTW coincided with huge layoffs across all industries. The first goal of the emergency fund is to protect it and the (distant) second is to earn some yield, subject to not losing capital. In today’s low-rate environment one of the worst moves is to “reach for yield” and put your emergency fund at risk. The liquidity of stocks is fine–you could sell your entire portfolio in a matter of minutes. But in this context the relevant question is if you were forced sell your portfolio in a matter of minutes what is the potential loss you could incur in a market dislocation.

  21. LargeTalons says:

    What about using a TIPS EFT for the bulk of an emergency fund? I realize that does introduce some interest rate risk, but if most of your fund ends up sitting idle for years on end at least it will be protected from inflation. Isn’t this similar to buying I-Bonds without the liquidity issue?

  22. Not sure if anyone has considered doing (12) 1yr CD ladder where one CD matures each month. It’s like getting an extra paycheck each month and if you don’t need the money, just repurchase a 1yr CD again. If you lose a job, you’ll a steady cash flow for next 12 months.

    I’ve started building this this and just added I Savings Bond to the rotation as well.

  23. Have the early withdrawal rules changed at Ally Bank? Website says: “Automatic renewal at maturity. If you make an early withdrawal, you will pay a penalty.”

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