In recent years, there has been negative convergence in emergency investor funds. On one hand, the financial crisis has underlined the importance of building up a liquidity cushion to cover its costs in the event of a job loss or unforeseen expenses such as car or home repairs. At the same time, adequate investment returns for an emergency fund have become virtually nil.
Investors may be tempted to minimize or eliminate their emergency funds, and rely on other sources of emergency funding, such as a mortgage line of credit, as a back-up plan. Or they may be inclined to venture into higher-yielding securities with higher risks such as bond funds, bank loan funds or even high-quality dividend-paying stocks.
Even though you are certainly spending more time on your long-term portfolio, it is still worth paying attention to your emergency fund portfolio in terms of size and content. Below are a few tips for building your own.
- Find The Best Risk-Free Return Possible
While it may seem tempting to venture into riskier investments looking for a better return on your emergency fund, it is not a good idea. Yields on high-quality short-term bond funds are no higher, and in some cases, even lower than the yields you can get with a high-rate online savings account. When you consider the fact that investors in bond funds will experience slight price volatility, it becomes evident that real liquid instruments are a better option.
To get a return potential that is sufficiently higher than the cash flow you bring, be it bond funds, investments in stocks or personal loan Singapore, you will have to be inclined to risk that your emergency fund, may be at its lowest point when you need it.
- Consider Dividing Your Emergency Fund In Half
If you have decided to be careful and build a large emergency fund, you may want to consider dividing it into two parts. For example, you could save three to six months of living expenses in a typical (or more) emergency fund investment: your checking or savings account, GIC, or money market mutual fund.
Because these risk-free investments provide virtually no return, you could invest another six months or more of your expenses in a financial instrument that would offer you a slightly higher return but which would cause some fluctuations in your capital. A short-term bond fund would be adequate for this purpose.
- Plan For Other Safety Nets
The low-yield environment has prompted some investors to forgo an emergency fund entirely and turn to other sources of emergency funds, such as a mortgage line of credit. These options should not replace an emergency fund, but they can be a secondary reserve in case your emergency fund shrinks, and you still need cash.
For homeowners with good capital in their home, a home equity line of credit is a good option. For this strategy to work, Crawfort Finance advice that you should only use your home equity line of credit if there is a real financial emergency, and only if you have exhausted all other sources of funding.
- Maximize Your TFSA
The advantage of the tax-free savings account is that if you make a withdrawal, you don’t lose your contribution room as you would with an RRSP (Registered Retirement Savings Plan). As a result, the TFSA is ideal for an emergency fund. TFSA contributions do not generate a tax deduction, but any growth or distribution generated within the plan is not taxable, as are withdrawals from the account.
However, since an emergency fund should hold risk-free, short-term assets, and since these holdings will have low returns in the current fixed income market, tax savings on income will be low. Depending on your circumstances, it would be better for you to hold high-yielding stocks or bonds in your TFSA to maximize your tax savings, and to place your emergency funds in a non-registered account.