A reader writes in, asking:
“We’re in an unusual position: We have no debt (including no mortgage), no kids, and live well well below our income. Should everything extra go into investments? I don’t suppose it’s reasonable to say I have $100K in an ‘emergency fund’?”
Unless your bank is paying you an unusually high interest rate*, I don’t see a lot of benefit to keeping a six-figure sum in cash. Even if you have a very low risk tolerance and are on pace to meet your goals with modest returns, there are a handful of investment options that are very low risk and likely to earn more than typical savings/checking accounts.
CDs, for example, can be a good choice. Allan Roth has often written about finding long-term CDs with low penalties for early redemption (e.g., Ally Bank’s CDs). That way you can get the (relatively) high yield of a long-term CD while still being able to break the CD to reinvest the money at a higher rate if rates rise. And if you stay under FDIC limits, credit risk is virtually zero.
Or, as we discussed recently, I Bonds are currently guaranteed to keep up with inflation (before taxes, that is). Like CDs, I bonds have basically no credit risk. And because you redeem I Bonds directly rather than selling them on the secondary market, there’s basically no interest rate risk either.
A TIPS fund can make sense in some cases, but the downside here relative to I Bonds is that the (inflation-adjusted) yields are negative all the way out to 20-year maturities (as of 4/5/13). And if you go further out along the duration spectrum, you take on significantly more interest rate risk.
We’re in an odd place these days where the distinction between emergency fund and normal bond holdings is becoming rather blurred, given that the typical emergency fund candidates (e.g., CDs, I Bonds) have yields roughly as good as (and sometimes even better than) the typical choices that would be used for the bond portion of a portfolio.
*My favorite place to shop for rates is the Deposit Accounts website. I often find that they have a more thorough collection of rates than many other sites that appear to primarily just pitch banks that pay a commission.