We’ve both always had an ‘emergency fund’ since the day we started working. When we married we merged our rainy-day money. We never called it anything in particular. It was just money that we kept at all times in the expectation that when, not if, the layoffs hit we’d need something to pay the rent and buy food. As the years went by and the children joined us we’ve increased the amount in this safety net. We’ve weathered many downsizings, resizings, diagonal slices and reorgs. And now it looks like another round of layoffs is looming yet again so we are happy we have money ready to ride out any gale. Recently, though, I’ve realized that we need to have a strategy for this emergency money because if we don’t invest it properly it is losing value to inflation.
It’s Not a Known Size of Emergency Fund If the Value Fluctuates
Obviously, we could invest our rainy day money in the stock market in ETFs, mutual funds, real estate income trusts, or individual stocks. That’s what we do with some of the cash we have building up to buy our next cars (hopefully not for another 10-15 years since the Camry is a 2012) and long-term home upkeep items (like the new roof fund and the new furnace fund.)
But those savings for future spending are not for emergencies. We could live without a new car. We could patch a roof and burn a lot of wood to keep warm if we had to delay our home maintenance for a time. If the stock market took a dive right when we planned to spend that money we would be annoyed and delayed but we could wait it out and get at it after at least a partial rebound.
Our emergency fund is different. We steadily need cash readily available to pay for our insurance, food, heating, electricity, and water. We could, if desperate, do without a phone and the internet, defer property taxes, and stop driving and therefore not buy gasoline. We already don’t have cable and we’ve paid off our mortgage. While we have pay cheques, we have a steady stream of cash coming in to pay these necessary bills. The emergency fund is meant to take over, though, if we were unexpectedly out of paid work.
Having to sell stock market holdings to pay the necessary bills wouldn’t appeal to either of us. Yes, they could be way up: if so, then we’d have to realize a capital gain and pay tax on it. That wouldn’t be too bad because if we were using our emergency fund we’d be in a low tax rate year anyway. But the investments could be way down: if so, we’d have to make a paper loss a real one. Yes, we could apply the loss to any future non-registered capital gains but that wouldn’t put any rice on the table today. And it would add the stress of wondering if we should sell now before the market slipped more or sell later in case the market rebounded a bit. We’d rather just have a known amount of money available in cash ready to use.
It’s Not an Emergency Fund if You Can’t Get It When You Need It
For years, keeping the money in a high interest savings account, like one at Tangerine, was good enough. The account paid just slightly more than inflation.
And even more strangely, generally these HISAs paid the same or a higher rate than a 1-year term GIC.
Now, however, most savings accounts are paying interest at a rate lower than the rate of inflation. And the rates for 1-year term GICs are higher than the HISA rates.
The problem with a GIC, though, is that in most cases it cannot be cashed prior to maturity. (Some can be although they are often issued with a lower interest rate than the non-cashable ones.)
What good is an emergency fund if you can’t get at the money when you need it to pay the bills?
As I pondered that, I realized, though, that our bills don’t come due all at once. Most of our bills are due monthly, a few every second month, and others every quarter. We don’t need our entire rainy day fund the day we stop getting a pay cheque. We need a steady stream of money just like we get from our bi-weekly pay deposits.
When I realized that, I decided we could improve our plan for managing our emergency fund. We could improve the overall interest rate earned and reduce the loss in value due to inflation.
What Is Our Strategy for Investing Our Emergency Fund?
We don’t need a large chunk of cash ready for the day we suddenly are unemployed. That’s because we already have a fairly large amount sitting in the bank for discretionary spending (like school ski trips) and to waive any fees by holding a minimum balance in the Big Bank accounts. OK, and also because we always have a float in the Big Bank chequing account in case we need to help someone immediately by writing a cheque. (It’s happened and it’s great when you can do it without waiting for 2-3 day transfers etc.)
So what we really need is to have an amount equal to our required (not regular) spending become available in cash each month.
So that is the amount we need to have in a GIC maturing each month.
For example, say our “bare bones survival” spending was $2000 per month. (It’s actually lower, but that’s because we don’t have rent or a mortgage to pay.)
Our strategy is to buy a one-year GIC each month with a face value of $2000. Then, one year from now, each month a GIC will mature paying out the $2000 principal and the interest.
If we are not in an emergency situation, we will re-invest that principal for another 1-year term. If inflation has raised our cost of living, we will also reinvest some or all the interest. We may even have to add additional cash if inflation is really high. If inflation has been lower than the rate of interest earned, we will take the amount of interest that is not needed for re-investment and add it to our regular savings and investments.
This plan will be a bit slow to implement for the first time because each GIC has to be purchased as each new month of the year arrives. In the interim, the balance of the fund will have to wait in a high interest savings account. (I actually started this in November so only 10 more months to go!)
I’ve currently picked our daily interest savings account at Oaken Financial to hold the balance of the fund. We were making about 3% interest on our HISAs are Tangerine and PC Financial due to short-term promotional rates in the fall but those rates have now ended. Oaken is paying 1.75% right now; Tangerine 1.3% and PC Financial 1.3%. If a good promotional rate is offered, I’ll transfer the funds electronically. It’s quick and easy to do online.
What Rate Can I Expect to Earn for 1-Year GICs for my Emergency Fund?
That’s hard to answer. At online brokerages like BMO InvestorLine and RBC Direct Investing in 2014, rates for 1-year GICs varied from about 1.75%-2.1%. InvestorLine requires a minimum investment of $5 000 in a GIC, though, in a non-registered account. For a non-registered account, RBC DI requires a minimum investment of $20 000 for a 1-year term! So using a brokerage account wouldn’t work particularly well for my emergency fund.
Right now, until December 19 actually, Oaken Financial (which is really Home Trust) is offering 2.4% on a one-year term non-cashable GIC. It may drop down to 2.15% tomorrow.
Tangerine is offering 1.35% today, December 19, 2014.
PC Financial is offering 1.392%.
So for now, I’m going with Oaken Financial.
I’ll try to keep an eye on our personal rate of inflation to see if our fund is losing value quickly or not. I think if I can get 2% or higher by using GICs, though, that we’ll be close to breaking even.
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How do you ‘invest’ your emergency fund? Are you playing stock market roulette with it and hoping the markets will be up if you ever need to cash out your chips? Is it mouldering at 0.25% at a Big Bank? Please share your strategy with a comment.
