Emergency Fund Alternatives

Emergency Fund Alternatives

Emergency Fund Alternatives

Hello again $wanigans! Thanks for checking back in with The Green Swan. Today we are going to continue our discussion on emergency funds. In a previous post titled Rainy Day, Rainy Month or Rainy Year I discussed how big of an emergency fund is necessary and many common considerations we each need to make. We’ll expand on that earlier post with more today regarding the opportunity cost of maintaining an emergency fund and alternatives to emergency funds. Lastly, I will end today’s post with details on my “emergency fund”.

The Opportunity Cost

Dave Ramsey suggests maintaining an emergency fund in a separate, stand-alone bank account (e.g. checking or money market account). In the previous post on emergency funds, I disagreed with Mr. Ramsey that the emergency fund should be able to cover three to six months’ worth of expenses. And this week I am disagreeing with him that it should be held in a separate account.

Let’s establish the opportunity cost before we go into alternatives. Mr. Ramsey is suggesting we hold $15,000 or more in a bank account earning no interest. With good alternatives to an emergency fund, we could rather invest this money in the stock market with expected long term returns of 8% or a stock / bond mix returning ~6% or so. Since I’m a fan of investing to win, I will use the 8% return as my opportunity cost.

Investing $15,000 at 8% would accumulate to over $22,000 in just five years, resulting in an opportunity cost of over $7,000! Over ten years, that account would grow to almost $32,400, or a $17,400 opportunity cost.

So thanks, but no thanks Mr. Ramsey, I can do better than just letting my $15,000 sit in a 0% interest checking account.

Alternatives to an Emergency Fund

Alternative #1: Open a Taxable Brokerage Account

Instead of setting aside $15,000 in a checking account, invest it in a taxable brokerage account and put your money to work. You could buy stock or bond index funds and keep it simple. I note there is a risk of losing money when investing in stocks or bonds, but over the long term it will be your best option.

Another concern may be that it is not liquid to get access to cash in time of need. I would refute that as a misconception. If you needed access to cash in time of emergency you could sell your index funds immediately, the sale would settle in one to two days, and you could then transfer that money back to your checking account same day. You could easily get access in less than a week and as quickly as three days.

I opened my brokerage account at Firstrade over ten years ago (after realizing how expensive Vanguard’s brokerage account is) because of its reputable online platform and low costs / trading fees.

Alternative #2: Open an IRA Account

If you are already investing for retirement, you may very well have an IRA account open already. If so, remember that you can always get the principle contributed to an IRA back without penalty (or tax in the case of a Roth IRA). Any gains you have made in an IRA cannot be liquidated without penalty, but the initial contributions you made can be. There are exceptions to this rule though, including penalty free withdrawals for medical expenses; however, I’d advise speaking with a tax professional to help determine the amount of penalty free withdrawals that can be made.

As mentioned above, my brokerage accounts are with Firstrade. Between my wife and I, it is nice having all our accounts in place which include five accounts total (each having a Roth and Traditional IRA and my taxable brokerage account).

Alternative #3: Open a Home Equity Line of Credit

If you are a homeowner and have been diligently paying down your home loan, you may be able to access that capital in time of emergency by opening a home equity loan. In my mind, this is one of the primary benefits of owning a home. This process can be completed easily online through LendingTree, one of the most popular and reputable companies out there.

The downside is that there will be fees and expenses related to accessing your home’s equity (appraisal, application fees, lien searches, etc.), but it is nothing compared to the cost of letting your money sit idle in a checking account (with the significant opportunity cost outlined above). Another downside is that it will take a few weeks before the money is ready. However, if you need more time and you have a forthcoming emergency bill for medical costs, home or car repairs, etc., you could consider putting it on a credit card and subsequently paying the credit card off in full when that bill comes due. This would help buy you some more time to get a home equity loan established.

Alternative #4: Personal Loans

A personal loan would be another decent option in time of emergency. While this may carry a higher interest rate than a home equity loan since it would be unsecured (a home equity loan is secured by the house), it will depend on your income / credit score and you could still get a competitive rate. Personal loans can be accessed from basically any bank, including LendingTree, with applications online, approvals within minutes, and funds available same-day. Being approved for personal loans with bad credit when you have an emergency can be a challenge. Learn more about how to improve your credit for better chances of approval by visiting The Ultimate Guide to Credit Repair (2017 Edition) – AAACreditGuide.

From purely a financial and cost perspective, I would still consider this a better alternative to Mr. Ramsey’s suggested bank account.

  • Let’s assume you need to $10,000, you borrow this via a bank personal loan, and it calls for fixed interest only payments of 10% (I’m assuming a conservatively high rate, a lower rate would be possible with a good credit score) with principle balance due in 3 years. This would result in total interest expense over the life of the loan of $3,310.
  • Alternatively, assume you listened to Mr. Ramsey and parked $10,000 in a checking account earning you 0%, with an opportunity cost of 6% invested in a mixed bond and stock brokerage account. And of course you don’t know when you would use it, so it sits there indefinitely. But over just 5 years of idleness, you would have incurred an opportunity cost to the tune of $3,382.

My “Emergency Fund”

As you know from the previous post on emergency funds, I target a minimum of $3,000 in liquidity (checking and savings account balances). While I maintain a checking account at a large national bank so that I can conveniently get access to it anywhere, I prefer to keep as little as possible in it. If you can’t tell, I really dislike having money sitting around idle, so you probably aren’t surprised to hear that I maintain my savings account through an online high-yield savings account. This offers a better interest rate than you can find at typical brick-and-mortar banks.

Online savings accounts typically link easily to traditional brick-and-mortar checking accounts. This allows me to conveniently transfer money back and forth when needed with only a day or two float (clearing or lag time).

Maintaining a minimum of $3,000 in a combination of checking/savings accounts is what I consider “bare-bones”. But in times of emergency when I need access to a “rainy day” account, I buy time by putting all charges on a credit card. I work to build my liquidity up from $3,000 to pay off the credit card in full when it comes due.

While I’ve never had a “rainy day” so bad that I had to take further measures, my next step would be liquidating a portion of my taxable brokerage account. This account serves a dual purpose, supporting emergencies in worst-case scenarios as well as for my retirement. I have built this over time to provide ample cushion (although just recently liquidated a big chunk to fund my small business investment opportunity).

My next step after that would be opening a home equity line. The rationale of opening this rather than liquidating my IRA is to preserve the beneficial tax treatment of the IRA. Since the cash need would presumably be temporary, I’d rather take on a loan and pay the interest costs than sell IRA assets and lose their tax benefit and the opportunity cost of maintaining the assets invested.

Thoughts?

Let me know what you think of this plan in the comments below. Am I crazy for bucking conventional wisdom? How do you plan for the inevitable “rainy day”? Do you have emergency fund alternatives?

Thanks for taking a look!

The Green Swan

Work Harder, Work Smarter, Retire Earlier and Find Your Beach

 

Products that may help you on your financial journey:

Personal Capital – A complete tool to monitor your personal finances
Betterment – Automated investment services and tax loss harvesting
Discover Bank – For a high-yield savings account
Motif Investing – Low cost investment accounts

 

Disclaimer: This post is for informational purposes only and should not be construed as a recommendation or advice. Please reference my disclosure page for more information.

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71 Comments on "Emergency Fund Alternatives"

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Apathy Ends
Guest

I don’t think you are crazy Mr Swan, big fan of the high yield savings accounts for housing emergency funds and a liquid brokerage account is a viable option.

As a side note – check out that 5/1 Arm interest rate! May be time to refinance

Vicki@Make Smarter Decisions
Guest

Hi GS,
We use your alternative #3 through our local bank for our emergency fund. We also had our mortgage there as well. They do no fee HELOC’s as long as it remains open for 3 years (and you don’t have to ever use it). So that was a no-brainer for us! We’ve had one open with them ($35,000) for years and tapped in to it a few times – and then paid things off a few months later. The interest can be deducted in certain situations too.

Aaron @IncomeHoncho
Guest

All your tips are on point. I believe people have a tendency to spend when funds are liquid, that’s why I prefer to put it in a brokerage account where it’s not TOO liquid so it discourage me from cashing out. But if you have a strong will, having an extra $1k Cash is not too bad in an emergency.

Mr. SSC
Guest

I think when we pass through this window of layoffs, no second income for a few months, and the O&G downturn, we’ll probably go with route #1 and put it in a liquid account. Even money market accounts are still only 0.8-1% interest which is essentially nothing, so yeah a higher return on that will be the way to go. Also, if we get into a situation like Vicki when we move and can have a HELOC to tap into, that would be good as well. We’ll see what the future holds, because right now, it’s holding a lot of cash, lol.

Physician on FIRE
Guest

The credit card(s) you already have can be yet another backup source of ready cash. It’s not unusual to receive those blank checks that carry little or no interest for a period of time.

Of course, never put money on the credit card that you won’t be able to pay back before the rates are jacked up. I used a couple of those checks to help fund our purchase of a six-figure waterfront lot some 9 years ago, knowing I’d have the earnings to cover them over the next few months. A bold move, but a 0% interest, it worked in my favor.

Stefan - The Millennial Budget
Guest

I pretty much will be following your emergency fund process should something happen except for the home equity line as I do not have a home. For some reason many people keep skipping over the fact that stocks are liquid assets that you can get in just a couple days, or less depending on your broker, to pay any bills. I think having some cash on hand and floating it on a credit card, especially one with a rewards system, is the best way to beat the system and make your money really work for you.

John
Guest
JW, I’ve been thinking a lot around emergency funds and I’d have to disagree here. You mention you’ve never had a severe rainy day, but that’s exactly what these funds are for…the unexpected. Sure, the money may not be earning any interest but that’s not the purpose. The purpose is for it to be there when you need it to be. The risk of investing your emergency fund is that you might have to sell when stocks tank rather than riding out the storm. And people are most likely to lose their jobs during a financial collapse. 8% might be reasonable over a long period of time (if we assume past performance predicts the future) but emergencies can happen in 2 yrs or maybe tomorrow.… Read more »
EarlyRetirementNow
Guest

Awesome post. Couldn’t agree more! I love your calculations on the opportunity costs!!! We wrote a popular post about this topic a while ago:
https://earlyretirementnow.com/2016/05/05/emergency-fund/
Our EF is zero (except for maybe $1000 of cash in a checking account) to avoid the steep opportunity cost you pointed out. As EF we use in that order:
1: credit card float, the interest free grace period we get by paying off our bill in full every month
2: positive cash flow from paycheck. If an emergency strikes, we simply save less that month. For us in the FiRE crowd, we should all have that positive cash flow.
3: home equity line of credit
4: our investment portfolio

So far we never had to go to step 4.

Brandon Abernathy
Guest
Brandon Abernathy

What about the event of unexpectedly losing a job? I know there are certain warning signs, but it’s not always predictable? That takes away options 2 and 3.

Martin - Get FIRE'd asap
Guest
I can’t understand why someone as financial prudent as Dave Ramsey would advocate having such a significant pool of funds sitting around doing nothing. My emergency fund consists of only $1,000 in case that sits in a ‘high’ interest account but I think it’s good to have a small amount of cash just in case. If I had the need for a larger amount it could be drawn from a number of sources. If it was required immediately, payment would probably be made by credit card which attracts no interest if paid in full each month. That gives me up to 60 days to draw down funds from either my index funds account or from the revolving credit facility on my property. Either way is… Read more »
Jon @ Be Net Worthy
Guest

I have the same aversion to “idle” cash as you do! A few years ago we took our emergency savings and paid down our mortgage and then opened up a nice hefty HELOC. We’ve actually used it from time to time, it is so handy. We have enough equity in the house now that even if the housing market takes a hit, there’s little risk of losing the HELOC. It works for us.

DC @ Young Adult Money
Guest

I go back and forth on this. We do have a 3 month emergency fund, but I also think of some of our stock investments as a secondary emergency fund. After all, if I ran into financial problems and depleted my emergency fund, I technically could always sell the stocks. Problem is I don’t WANT to sell the stocks – ideally I’d hold them “forever.”

Amanda @centsiblyrich
Guest

Thanks for the suggestions – this has been on my mind a lot lately. There have been some times when we have had 6+ months of cash sitting in a savings account earning 1%. At the time, I subscribed to conventional wisdom and felt more secure with a pile of cash sitting there. I’m thinking twice as I hear others using different options. It doesn’t make sense to have that much just sitting there doing nothing.

We are now considering two of your suggestions – putting it all in our taxable account and/or opening a HELOC. We are refinancing the mortgage next week and just had an appraisal done, so maybe now is the perfect time to do it!

Emily @ JohnJaneDoe
Guest

I’m not sure your info on IRAs is complete. For Traditional IRAs, you can’t take the money out without the 10% penalty unless you are over 59 1/2 or meet certain exceptions (medical expenses, first time home buyer, etc). The IRS website mentions only one exception to this rule for contributed amounts, and it only applies to the contributions of the current tax year if made before any tax return or extension is due. That means at most two year’s contributions would be penalty free. (If you withdrew this year, 2015 and 2016 contributions if your 2015 is still on extension.)

For Roths, you can take the contributed amount out without penalty, but only after it has been invested for at least 5 years.

Ty @ Get Rich Quickish
Guest

Looks like I’m late to the party on this post!

My emergency fund is my credit card. Because we’re talking about an emergency here, I’d use my cc to cover me in a pinch and sell stock to pay off the card.

I know that my employer offers a hardship loan for up to a % of my salary. I don’t know the details because, thankfully, I’ve never had to use it, but that might also be an option for someone.

Jacq
Guest
Jacq
I have an interest earning savings account, which transfers to checking in a few business days. Put the immediate need on the credit card & transfer the money. I have had unexpected unemployment, lasting from 3 to 5 months. In my industry, it -is- a reality to need a 3-6 month emergency fund. Unemployment helps, but with taxes taken out, it covered rent. Food, power, internet to search for the next job, gas to drive to the interviews – all came from savings. That was a big part of why I refused jobs that paid a lot less (< $20 k less). I can 'make it'/'survive' on less, but living frugally is what allows me to build the emergency fund for the perhaps not so… Read more »
Maggie @ Northern Expenditure
Guest

Ever since I realized how easy it is to get money out of my brokerage fund, that’s where I keep my emergency fund. Maybe it’s risky to invest, but WAY more fun! 🙂

Claudia @ Two Cup House
Guest

Our emergency fund is lean at the moment, but we have an e-fund funding plan. Where to store it is a different question. Now that I see you use a brokerage account, I think we’re going to have to do some research. 🙂

Rob @ Money Nomad
Guest

These are all plausible solutions. I wouldn’t recommend the loans and line of credit, but the investment account certainly works. I actually use Betterment — so that I receive a decent return and can access the funds quickly. I also, however, keep a few grand in my bank just as a cushion (and to ensure those credit cards get paid off monthly).

Great article and keep it up!

Patrick
Guest
Patrick

Hey Swan, nice post. I like the idea of investment, so I keep mine in a relatively bond heavy 80 bond / 20 stock betterment account. It has only a little risk, but it grows and gets dividends.

Finance Solver
Guest

$15,000 is a lot of money to save for an emergency, I have around $5k as my emergency account. The rest are in 401k’s, taxable brokerage account, and in savings ready to pay down my student debt once my grace period is up. It has been nice starting to get a steady paycheck!

Dividends Down Under
Guest

Hey JW,

You know know what our situation is so we’re still going to hold onto a lot of cash. But I can completely see your side of things. At the moment Aussie savings accounts pay around 3%, which isn’t bad at all, all things considering. Of course in an emergency situation, ALL assets are up to be sold to solve the emergency, but I think fire sales aren’t the best way to cover yourself.

Tristan

Kelsey @ Tealmama
Guest

I always enjoy reading your posts because they give me a lot to think about! I think we’ll take a balanced approach. Decrease our emergency fund amount as we get more and more comfortable plus use a home equity line of credit as a backup. We used this as a “bridge loan” (they just recently changed this term – no longer a bridge loan but a HELC) to buy our house when we moved before our other house sold. And I was surprised how inexpensive it was. Firstrade is definitely something on my list as well.

Mr Crazy Kicks
Guest

I’m with you on this one. All of my investments can be tapped within a couple of business days, and credit cards can cover the unexpected until that cash is available. So unless someone is holding my chickens for ransom and demanding a large cash payment within 2 hours “or else,” I think I should be covered.

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Xyz from Financial Path.
Guest

I like to use my HELOC in case of emergency and invest everything in the markets instead of keeping a large sum in a savings account. I do try to keep a few thousands in a high interest savings account for the small stuff but never “3 to 6 months of expenses” worth!

Jason
Guest
I agree with you on the emergency fund, although I have raised my threshold to $5000 for liquid. I just keep it in an Ally Bank account so that I can’t get to it. My conundrum is what do I do from there. Do I take the rest of the money and automatically invest it? Pay down debt? Save for something a little more. Part of it is because my wife and I have a high amount of student loan debt. So much so that it will take a few years to pay it off (part of it because of student loan forgiveness) but do I just take it and plunk it down on a huge chunk of debt or create another account build it… Read more »
Mr. PTM
Guest

I would also agree with John here, but to each their own. I view an emergency fund as self-insuring for a variety of circumstances like sudden job loss (or a FU/Freedom fund), however I don’t think that means you can’t earn a return. I’ll soon have $25k earning an FDIC/NCUA-insured 4+%.

MR. All Things Money
Guest
I sleep well at night because I have enough in an emergency fund to cover any unexpected big expenses. I want this money to be available at a moment’s notice and it has to be there in full when I need it. If I were to put it in an Index Fund and the market crashes when I need the money, I would be forced to sell my Index fund at a lower price and get less of my money back. The point I am making is that emergency fund should not be invested as such its value can fluctuate with the market. I am fine with putting the emergency money in a CD or an online bank account earning 1% because my principle amount… Read more »
Mo
Guest

I’m trying to put as much money as I can towards my mortgage principle, so I only have an emergency fund of $2000 right now in a high interest savings account. I also have a low interest line of credit that I keep in case of emergency.

Daryl Jirsa
Guest

At first glance, it seems slightly irresponsible to take out more debt for an emergency, but a ?200 fee in the case of an emergency is greatly favorable compared to the ?25,000 difference noted in scenario 1 above.

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[…] been thinking a lot about emergency funds. I read some great articles by earlyretirementnow.com, thegreenswan.org, and unchained55.com, and I believe that the role of an emergency fund is certainly under-discussed […]

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[…] There is definitely more to discuss when it comes to emergency funds, but this is getting long so let’s put a pin in it there. For more, check out my emergency fund alternatives. […]

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[…] toward FIRE with growing investment account balances and stable employment, there may be better emergency fund alternatives available to you. Either way, the tips below can help get you back on your feet during a cash […]

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[…] Emergency Fund Alternatives The Green Swan doesn’t follow conventional advice on emergency funds. In this post, he discusses the opportunity cost to keeping the money in a regular savings/checking account and details 4 alternatives in lieu of standard advice. […]

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