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Author: Kapitalanleger One star, 50 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 35400  
Subject: Emergency Fund Date: 10/2/2007 4:09 PM
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I have an "emergency fund" from which I occasionally make small withdrawals (through check-writing) but which I otherwise hold for living expenses in case an emergency arises in the next five years.  I am wondering whether it is better to have such an "emergency fund" invested in (a) a money-market fund, (b) a short-term bond index fund, or (c) some combination of the two.

Many thanks.
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Author: jbking Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 21770 of 35400
Subject: Re: Emergency Fund Date: 10/2/2007 4:14 PM
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Greetings,

The key is to understand the risks of the short-term bond funds which when interest rates rise can cause a loss in the NAV that may be a bit of a shock to some extent. In addition, don't forget that each time you make a withdrawal on a short-term bond fund it is a capital gain or loss depending on your basis so there is some more bookkeeping to be done if you do use that. IMO, you have to decide whether you can accept the risks of a short-term bond fund and if so then what mix is appropiate as eventually there will be rate hikes and this can send a bond fund's NAV down, even a little that causes some folks to be upset.

Regards,
JB

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Author: theHedgehog Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 21771 of 35400
Subject: Re: Emergency Fund Date: 10/2/2007 4:23 PM
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<i>I am wondering whether it is better to have such an "emergency fund" invested in (a) a money-market fund, (b) a short-term bond index fund, or (c) some combination of the two.</i>

Due to the potential fluctiations of bond fund NAVs, it's probably not a good idea to put emergency money in a bond fund - you may come up short when you really need it.  The same is probably true of a money-market fund.  More appropriate would probably be either a high interest savings account or a short term CD that you continue to roll to the best interest rate.  There might be an early withdrawal penalty if the timing of your emergency was bad, but with a short term CD, the penalty will be very small.

Most market investment vehicles have some element of risk to the underlying prinicipal.  You do not want risk in an emergency fund, unless you have sufficient other assets to make up for it.  But, in that case, it wouldn't be so much an emergency fund as a cash flow fund.

Hedge

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Author: Tredos1 One star, 50 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 21772 of 35400
Subject: Re: Emergency Fund Date: 10/2/2007 4:47 PM
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Hedge wrote:
<i>Due to the potential fluctiations of bond fund NAVs, it's probably not a good idea to put emergency money in a bond fund - you may come up short when you really need it.  The same is probably true of a money-market fund.</i>

I'd like to understand more about the risks of a money market fund you allude to. I keep my emergency fund in an Insured Money Market Account at the credit union. This account gives me acceptable interest (4.25%) and is insured. What can go wrong? I know I can get more interest in CDs but I like the liquidity of just doing an electronic transfer to the checking account if I need it.
Thanks,

Tredos

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Author: theHedgehog Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 21773 of 35400
Subject: Re: Emergency Fund Date: 10/2/2007 4:57 PM
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>> I'd like to understand more about the risks of a money market fund you allude to. I keep my emergency fund in an Insured Money Market Account at the credit union.

A Money Market Account is not the same as a Money Market Fund.  The MMA has no risk.  The MMF does.

Check these links:

http://www.investopedia.com/articles/02/120602.asp
http://www.investopedia.com/terms/m/moneymarketaccount.asp
http://www.investopedia.com/terms/m/money-marketfund.asp

Hedge

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Author: Lokicious Big gold star, 5000 posts Feste Award Nominee! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 21774 of 35400
Subject: Re: Emergency Fund Date: 10/3/2007 9:16 AM
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I'd like to understand more about the risks of a money market fund you allude to. I keep my emergency fund in an Insured Money Market Account at the credit union. This account gives me acceptable interest (4.25%) and is insured. What can go wrong? I know I can get more interest in CDs but I like the liquidity of just doing an electronic transfer to the checking account if I need it. You money market at the credit union should be NCUA insured (assuming your total money at the credit union falls within insurance limits). What Hedge is talking about is money markets at a brokerage, which are not insured. (You can get insured CDs through a brokerage.) Actually, I believe there is some kind of insurance for brokerages, but it isn't government, which is presumed to be safer (though I saw in the news yesterday that the Democratic leadership in the House rejected out of hand the idea of Murtha and some others to raise taxes to pay for the war, which certainly restores my faith that eventually the US government will not be able to cover its obligations).

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Author: DeltaOne81 Big gold star, 5000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 21775 of 35400
Subject: Re: Emergency Fund Date: 10/3/2007 1:16 PM
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There *is* a difference between MM funds and MM accounts, but I think you guys are overstating the potential for 'risk'.

Money Market funds may themselves may not be insured, but many of their investments are. Much of what the ney is ultimately invested in is still CDs, etc, which in turn *are* federally insured. And even those investments which are not are things like commercial paper that is very short term, very high quality.

Finally, there's the last step of the brokerage itself, which would suffer massive reputation damage if their money market fund lost money. It is much much better for them to chip in a bit than to suffer losing the trust of millions of investors. On the scale of things to worry about, a money market fund losing money should be down there with being struck by lightning on a sunny day.


On a short term bond fun, the value will fluctuate and you can lose some money.

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Author: brucedoe Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 21777 of 35400
Subject: Re: Emergency Fund Date: 10/3/2007 4:37 PM
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There are other options that I think are better.  It is possible to get CDs, for example, that allow you to withdraw money.  I have one with BB&T called a Treasury CD in which I can make one withdrawal a month without penalty.  I've transferrred money from it to my non-interest bearing checking account by telephone which was accessible for check writing the same day.   It pays 3.5% now (down from 3.67% prior to the Fed Funds rate lowering).  I think there are some that will allow more than one withdrawal without penalty.

A MMF might be all right, but remember it is not federally insured.  but a varient on this might be Vanguard's Federal MMF.  It is not Federally insured, but will the Federal government really allow Freddie Mac, Tennesee Valley Authority, etc. go bankrupt?  It recently was paying over 5%, and you can withdraw money from it.  You just need $3,000 to start.  If you go below $1,000, there is some sort of annual fee.

E*Trade has a savings account (Complete Savings) that was paying 5.05% as recently as yesterday.  To make it work effectively, you might also need a checking account so you can transfer money.

brucedoe

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Author: brucedoe Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 21778 of 35400
Subject: Re: Emergency Fund Date: 10/3/2007 4:47 PM
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Delta

Though I don't know of a MMF that has broken the $1 setting, there are those that have been in trouble in the past.  In these cases, the parent organizations have infused money into them to maintain the $1 setting.  Some conseervative economists have objected to this on the basis that since MMFs get increased dividends, the investors in them should accept the increased risk.

I've read that commercial paper has dried up.  What this does to MMFs, I don't know.  So far as I know, MMFs invest in commercial paper, or at least that is the way they started.  I'm not aware that they invest in CDs.  MMFs are supposed to invest in very short-term vehicles and might, I suppose, get involved in overnight loans, but I'm surprised they get involved in CDs, unless there are very short-term CDs like one week.

brucedoe

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Author: theHedgehog Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 21779 of 35400
Subject: Re: Emergency Fund Date: 10/3/2007 5:30 PM
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>>E*Trade has a savings account (Complete Savings) that was paying 5.05% as recently as yesterday.  To make it work effectively, you might also need a checking account so you can transfer money.

I use etrade's Complete Savings account for my buffer zone between stocks and checking account.  Their MMF used to be higher, and when it was, I used that.

In spite of the advice that I give about keeping an e-fund, I don't have one, myself.  My thinking is that if someone asks, they need one.  My pension and frugal lifestyle provide enough insulation for me that I keep most of my funds in stocks at this point.  If the economic situation were to change, then I would change with it.  Whether I would be ahead of the curve is debatable, but I've benefited enough from the current expansion that that should more than make up for anything other than a catastrophic pullback.  In the case of such a pullback, all bets are off, anyway.  The usual 20% swings I get in my portfolio don't bother me as much as they used to.

Hedge

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