When we talk about investments we usually focus on the stock or bond markets, and how things like our retirement accounts are doing. The money that often gets overlooked is the 6 – 12 months of easily accessible “emergency” savings we should all have. People often think this means the money should be in a bank account, not realizing they may steadily losing money in the long term with this approach.
Banks offer a lot of services that are critical to our financial life. They offer easy access to things like mortgages and car loans, and most of us would never want to return to life before bill pay. When it comes to protection it’s hard to beat FDIC insurance, guaranteed! But that protection comes at a steep price in the long term.
It’s All About Inflation
The idea of an emergency reserve is that we hope to never use it, which means most of it sits and sits and sits. Maybe we use a bit now and then to buy a new washer or repair the roof. Inflation is a constant drag on interest rates that you can’t see, but begin to feel over time as things become more expensive.
The Fed generally like to see this rate over 2%, which means just to break even over time on any investment you need to earn over 2%, and assuming you pay taxes, you’ll need a bit more.
The nice thing about most bank accounts is they seem free. While there may be no up-front fees, real cost comes in the form of low rates on checking, savings, CDs, and FDIC insured IRAs. For example, today’s Wall Street Journal (5/9/18) quotes the annual yield for a five-year CD at 1.68%, and 0.45% for money markets for the banks they sample. Either way these will offer negative returns in the long run since both are lower than 2% and right now the most common measure of inflation is closer to 2.5%.
The punch line is that they are likely to always be less than inflation because of how these types of accounts are priced, they don’t “catch up.”
Risk is Relative
Beating inflation for long periods of time does require a bit more risk. The first place we look is US Treasury bonds and bills. US Treasury bonds are considered to have no risk of a principal loss because they are backed by the US government (just like your bank deposits). Prices do move on these, but if you hold one to maturity you will always receive 100% of your principal. Today the US 5 year note is yielding about 2.8%, good luck finding a five year CD at that rate. The best part, you can buy these inexpensively directly from the Treasury. They also offer inflation protected securities that will keep your principal amount current with inflation.
Is There an Easier Way?
Wouldn’t it be easier if we could just buy a portfolio of these bonds? Yes, and they are out there. There are exchange traded funds (ETFs) that hold portfolios of these bonds, and simply pay out the interest as dividends each month. As bonds mature they buy new ones. The risk here is that the prices do move with the bond market, but the investments themselves are simply US Treasury bonds.
For example, there is an ETF that holds US Treasury bonds that mature in 1 – 3 years currently yielding 2.38% at a very low fee. I assist many of my clients with managing their short term or emergency savings with this type of solution.
There are reasonable options that can help you overcome inflation, and still maintain an easily accessible emergency fund. Although we hope you don’t have emergencies and these funds can grow over time; in the event that you do, you’ll have funds available to cover your needs that have at least kept pace with inflation if not added to your bottom line.
At Buoyant we’re concerned about your entire financial picture, and helping you get the most you can out of your assets, even the mundane rainy-day fund.
If you have any questions about this or would like to learn more about short term savings option please shoot us a note or give us a call. We can point you in the right direction and may be able to offer some assistance with your entire financial picture.