It sounds crazy: I keep the bulk of the money I’d use in an emergency fund in a taxable investment account.
But maybe it’s not as crazy as it sounds. When you’re using a so-called high-yield savings account, you have a large chunk of capital sitting there, doing practically nothing. If you have the risk tolerance for it, my tiered approach to emergency savings might just help you grow your wealth while preparing your finances for setbacks.
Tier 1: Bank Account
I don’t put everything in a taxable investment account. Instead, I use a bank account for three to four weeks’ worth of expenses. You can choose the account you want.
I’ve been using a high-yield savings account, but I’m thinking of switching to the Radius Hybrid checking account.
Using a checking account would make the money more accessible in an immediate emergency. I like keeping close to a month’s worth of expenses in a bank account because I can get the money immediately if I need it in a true emergency. It gives me enough to live on while I liquidate the assets in my investing account.
Switching from a savings account, with its limitations and restrictions, to a checking account might make the process easier. However, it’s important to practice discipline. Just because you can access the money easier with a debit card, it doesn’t mean you should. Remember, this is for emergencies.
Now, it’s clear that three to four weeks’ worth of expenses isn’t a sufficient emergency fund, so here’s where we get to the good stuff — the taxable investment account.
Tier 2: Taxable Investment Account
The second tier is where I build my emergency savings through consistent contribution. Each month, a set amount of money goes into my taxable investment account for this purpose. The account doesn’t have a target goal amount. Instead, because I’ve already got automatic contributions going to my retirement, HSA, and travel fund accounts, I just use the account as a way to build emergency savings — and a little more wealth.
I’m actually 100% invested in an S&P 500 index fund for my emergency savings. For some people, this might be too much risk to stomach. I know investors who prefer different asset allocations, using funds to split their emergency savings into 50/50 stocks/bonds, or doing something like a 70/30 split. However you decide to do it, it has to be something you’re comfortable with.
Over time, I’ve been able to build up the account to the point where it can handle almost any emergency, including a few months’ worth of covering my expenses. And it’s growing regularly, thanks to the fact that I don’t have it all sitting in an account with a comparably low yield.
How Do I Access My Emergency Money?
Accessing the money is fairly simple. I’ve only needed it twice in the last decade or so. The first time was when my basement flooded in 2010. We ended up with a bill to set things to rights. However, because the bill didn’t need to be paid immediately, I was able to sell some shares in my taxable investment account. Once the trade settled, I moved the money to my primary checking account and used it to pay the bill.
The second time I accessed my emergency savings was just a few months ago. After having my debit card number stolen in a data breach, my bank account was emptied. I used my short-term (tier 1) account to pay expenses while the issue was being sorted out. Then, I sold a small amount of my shares to replenish my account and bring it back up to a month’s worth of expenses.
It’s important to plan ahead when using this strategy. It takes seven to 10 days for me to complete a transaction with my online brokerage and have the money shifted into my bank account. With index fund settlement, and ACH transfer, you need a little lead time. That’s why I like having the short-term account. I can tap it while I liquidate the stocks.
Switching to a checking account would make things easier. I had to move a lump sum from my short-term emergency savings account into an alternate checking account in order to conveniently use it. Using an interest-bearing checking account could change the equation. I’d be able to just use the debit card with no issues during an emergency.
What if Your Portfolio Loses Value?
The biggest concern I see when I explain my approach to emergency savings has to do with stock losses. And it’s true. In 2010, I sold at a loss to cover my emergency costs. However, even so, I still had capital in the emergency fund — and that’s the point of the emergency fund. If you are fortunate enough to have lead time before your first emergency, you’ll probably not deplete it all in one go.
On top of that, because I sold at a loss, I was able to claim a tax deduction. Not only did I have the funds I needed, but my emergency ended up being tax-deductible. That’s not a terrible thing. And, because I automatically contribute to the account each month, I was able to rebuild the fund quickly, especially as the stock market bull run began.
In the end, how you manage your emergency fund is up to you. I’ve had good results from my tiered approach, and I like that I build my net worth while protecting myself in the case of emergency.