One question I see all the time is where should I put my emergency fund for good returns?
People are looking to optimize every single dollar, but at what risk?
Common suggestions I have seen, for maximum return include:
Offset mortgage for an emergency fund
Yes, the return is better, but there is a good chance you need the emergency fund when the economy is tanking. In such a scenario, there is a good chance that the price of your house has gone down, your reliability as a lender has gone down, and the banking liquidity has gone down. All this may result in the bank not allowing you to withdraw your own money and leaving it as security against the property.
Revolving credit mortgage for an emergency fund
Much the same as the offset mortgage. However, if you are still allowed to withdraw your money, you have to pay the prevalent mortgage interest rate for the privilege. If mortgage rates have gone up, you may even pay more to use the money than you received. In effect, you would have been much better off in a savings account.
Shares for an emergency fund
Much like the mortgages, your chances of needing emergency cash go up when the economy is performing poorly. The share markets could be down 20, 30, 40% or more. That is a huge drop in value to realise. You may have put in $40,000 and now need $20,000 for an emergency. If your fund has dropped 50% in value, then you only receive $20,000, even though you have used $40,000.
In any given year, historically, there is a one in four chance the markets have gone down.
Term deposits or 90 day notice savers for an emergency fund
Much lower risk than the other options, but still not very liquid. You can probably get the money fairly quickly if needed, but you will lose all the benefits. The banks will eliminate all returns if you break the contract.
Credit card for an emergency fund
30 days can be plenty long enough to pay back a credit card when the economy is booming and things are going well. But what if you take out a large cash sum for an emergency at a time when the economy is hurting? Maybe you have just lost your job. You could end up in severe debt, unable to pay it back, with astronomically high interest rates. That is a hard hole to dig yourself out of.
Emergency funds should be simple
There is a common misconception that you must always optimize every dollar. Yes, this is important for the majority of your investments. But your emergency fund is not an investment.
It is somewhere to SAFELY put your money should you need it an emergency. There has been no more recent example of how important an emergency fund than the covid 19 pandemic. Jobs were lost, incomes were reduced.
The worst thing is having no emergency cash at all.
The next worst thing is having to cash out from a fund where you lose money, or a fund where you are not allowed to withdraw from at all.
An emergency fund should be in a fund that is easily accessible at a moment’s notice and will not lose money on withdrawal.
There is no secret place to put your emergency fund that will deliver good returns at low risk. That is just not possible. You are not missing out on some magic solution. Keep it simple.
This will mean minimal returns. But who cares? At least you know you can access your money when you need it and you know how much you will receive. It is hard to put a price on that. The peace of mind is priceless in my opinion.
Leave the tinkering and return chasing for your other investments.
The information contained on this site is the opinion of the individual author(s) based on their personal opinions, observation, research, and years of experience. The information offered by this website is general education only and is not meant to be taken as individualised financial advice, legal advice, tax advice, or any other kind of advice. You can read more of my disclaimer here