Personal Finance

Changes To My Emergency Fund

Fortress

Emergency Fund Review

As my emergency fund grows to around 3 months worth of expenses, I’m starting to think about how to allocate future contributions. I think a good emergency fund should do two things:

The first is obvious! It should provide income incase of unexpected job loss, or a source of funds in a genuine emergency like urgent medical care, home damages that’s not insured etc.

The second is to provide peace of mind that should any emergency occur you’re well covered, at least for up to a year (life, trauma or income protection insurance can also be essential, depending on your age and family composition and could payout well in excess of a year if something really unfortunate happens).

Within a month or two, the fortress fund should be at 3 months expenses, or around $12,000AUD. At the moment, it’s in a high interest savings account, earning 3% interest p.a. I’d like to gradually build to 12 months expenses for the fortress fund. That might seem like a lot, but I’ll do it over a few years. A question that follows from this is where to allocate the extra funds. If 3 months of expenses is in cash (25% of 12 months), where should the other 75% go?

Bonds, cash or stocks?

I’ve decided that the certainty and ready access of cash is important for at least 3 months worth of expenses, so I don’t think will ever change. But the other 75% I’ve decided to invest in a tiered approach, with the second 25% going to Floating Rate Notes (FRN’s), the third 25% to Government & Corporate Bonds and the final 25% to highly diversified Equities.

Screenshot 2017-09-21 17.42.16

One caveat – when interest rates are low, like they are now, I’ll Invest by thirds into cash, FRN’s and equities but exclude Government and Corporate Bonds. Bonds would lose face value when interest rates rise. A diversified basket of floating rate notes have typically been difficult to access for investors in Australia, but recently a couple of managed funds and etf’s have come to market. The benefit of a FRN, which is a type of bond is that the interest rate ‘floats’ i.e. isn’t fixed over a set time period. Usually on a fixed-coupon bond (e.g. Government bond) the interest rate is fixed for a given period (say 10 years), and if market rates rise the face value of the bond falls, to compensate for the lower return a new buyer would get, compared to the market interest rate. With a FRN the coupon rate is reset, typically every 90-days and are relative to bank bill swap rate plus some margin. So as interest rates rise, the face value of the bond remains steady because the coupon rate on the FRN rises too.

Screenshot 2017-09-21 17.42.27

The tiered approach.

Using a tiered approach means that while the fortress fund is small it will be invested 100% in cash – earning OK interest, but guaranteed accessible and protected by the Australian Government Deposit Guarantee. Only as it grows will it progressively go into slightly riskier investments. These are still quickly accessible, liquid and unlikely to be lost to receivership on the whole. These should offer a slightly more attractive return for the entire holding.

What do you think of this new method?
How do you organise your emergency fund?

Read my disclaimer. I’m no pro!

13 thoughts on “Changes To My Emergency Fund

  1. Interesting approach. I personally keep 12 months of expenses in cash for now (though my expenses are a bit lower than yours). Bonds don’t seem to be a good bet at the moment, as you say interest rates are too low.
    To me, all money put into shares has a higher risk so in an emergency what if the market is down? I may not want to cash out. I’m quite risk averse though. Other people may be comfortable with a higher level of risk.

    1. Thanks for the very thoughtful comment Miss B – it’s a great point.
      I think it’s important to do whatever lets you sleep at night – in my mind the EF isn’t for speculation, it’s for peace of mind so I totally agree about being conservative. With the equities component, I’d most likely use a vanguard life strategy conservative or balanced fund, which are actually only 30-50% in equities. In the GFC these dropped by 4-6 percent, so the effect on the overall fund would be (.25 to .333) * (4% to 6%) = -1% to -2%. This would be offset by the cash interest and any FRN interest so it would probably be a flat year. The MSCI lost 40% during the GFC which would reduce the fund at most by 13% or so (1.6 months expenses). Over the last 20 years the MSCI world has grown 7.5% p.a. For me personally the long term growth I think would outweigh the risk, especially if extra risk was offset through trauma/IP insurance, which I’d certainly like to have in the next couple of years. TBH in the grand scheme it would be a minuscule difference if you had a larger share portfolio to grow wealth on the outside, so it probably wouldn’t matter much to be extra conservative!

  2. We’ve got three months fully funded, and an extra stash on top of that, until recently all in a high interest savings account. Like you I thought the balance had become too high, so I’m now moving it across to Vanguard. Safe? No. But it would have to be a perfect storm for it to be disastrous. A combo of the market crashing and both of us losing our jobs at the same time, and the insurance company folding. While this is a possibility, it’s a risk I’m comfortable with. Your plan sounds good to me – adding more diversification with a level of risk you’re happy with.

    1. Yeah we’re lucky to have such good high interest rate savings accounts here. Although I’m sure we pay for it through higher loan rates! Ha.

      Sounds like a good plan to move to vanguard. Do you plan to keep an amount in cash?

      I like Vangaurd a lot, would be great if they had ETFs like the life strategy funds or a lower initial investment into life strategy funds.

      Thanks for stopping by Mrs ETT.

  3. Hi wealthfromthirty,
    This looks like a reasonable plan to me, starting with cash first and building out as the size increases.

    One good thing about Tiers is that they provide some flexibility. If there’s an emergency and you need to withdraw some money you have the option to withdraw from cash first if the market was down, or from the investments first if the market was up.

    The most important thing about an EF is that the money is there when you need it. You can compensate for riskier tiers by assigning more money to those tiers. Typically the stock % can drop by 50% in a crisis, so if you have 60%/40% in a life strategy fund then you might expect a worst case of a 30% decline; having any extra 30% of money in that tier reduces the risk of the required amount of money not being there.

    I find quite a lot of “unexpected” expenses such as house repairs are actually to be expected, so I put money aside each month towards a new air conditioning system, or to replace kitchen appliances in the future etc. Pretty much anything I buy, I’m considering how many years of life I’ll get from it and how much money I need to put aside to replace it in the future. Having a clear definition of what EF money will and will not cover helps in sizing it appropriately.
    Best wishes,
    -DL

    1. Hey DL – glad you dropped by, my re-thinking of my EF was actually spurred from reading the changes you made to your EF/income fund. It was in the back of my mind but reading your post actually helped me think about options moving forward. With the flexibility, that’s one of the appealing things for me too; that in a pinch I have access to the funds immediately, and the cash component might indeed tide me over completely.

      Interesting thought on managing riskier tiers by increasing their funding. It would help for the long term for sure. Speaking of long term, it’s great you put cash aside for future expenses. I have a small account for that (car servicing, insurance etc.) but it wouldn’t cover big ticket expenses like a fridge, washing machine etc. not yet at least.
      Appreciate your comment!

  4. Hi wealth from thirty, nice pic! I love that of all the castles in the world, this is the one you use – because back in 2014 my husband and I had the pleasure of working here (Eilean Donan Castle) for 3 months while on a UK working holiday πŸ™‚
    Great blog by the way….

    1. Hey Jo, thanks for dropping by. That is wonderful you and your hubby got to work at this castle when you stayed in the UK – what was your role there?

      Thanks for the kind words on the blog πŸ™‚

      1. By day we worked in the visitor’s centre (which was to the right of this above pic – you can sort of make out the stone bridge that lead people back to the main grounds) in the cafe… The castle would see 400 visitors an hour in the peak season – that is a lot of coffee and sandwiches πŸ™‚
        By night we would help out with weddings – yes, you can get married in the actual castle! – serving champers, directing guests, helping the bride navigate stairs with her massive dress πŸ˜‰
        One day I might create a blog, and include the story of how we left Oz with $1500 (Β£800) and came back with $10,000 after 13 months in the UK. For now, I’ll just read other blogs – like this one πŸ™‚ Cheers

        1. What an awesome adventure. If you ever write that post let me know! It would be neat to see a wedding at a castle, very Monarch of the Glen. I’ve only visisted a few castles in my lifetime but they’ve all been spectacular.

  5. This looks like a reasonable plan although with super low interest rates in the US right now, I just keep most of my emergency fund in cash and I also have an allocation to bonds within my asset allocation that I could always tap into in case things go really haywire.

    1. Hey TITM, thanks for stopping by! Super low interest rates are problematic for many of us atm. At least borrowing is cheaper but I think a lot of people – at least in Oz – are over leveraged with β€˜cheap debt’; it isn’t going to take too much of a rate rise to really strain family budgets. Sounds sensible to have your emergency fund in cash, and access to bonds in your other allocations.

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