Dividend fund for emergency fund storage or otherwise?

[Neo_Zodiac]

I wanted to get some of your thoughts from the group regarding a good place to stash an emergency fund. I have about a year's worth of living expenses (~$20K) sitting in a high yield online savings account with Ally Bank making 1% in interest a year. As it stands now, I would be paying for that 1% gain at my marginal tax rate of 28%. It just feels wasteful having that much money sitting around earning below inflation. I already maxed out my 401k and roth IRA contributions.

Would it be better (in terms of growth and tax-efficiency) to invest some of that money in a dividend ETF like SDIV where the annual dividend yield is 7% paid monthly and paying for that 7% at the capital gains rate of 15%? If not, would a tax-exempt municipal bond fund (VTEB) be a wiser option? I was thinking about doing a tiered approach leaving $10K in the Ally account for liquidity purposes and routing the other $10K to a dividend ETF where it can have higher tax-efficient growth potential and using the gains for my housing fund. Would/does an approach like this make sense?

I'm not really well-versed financially and would appreciate any thoughts you all may have. Thanks!

[Zaphod]

Theres nothing wrong with wanting some more growth out of your e fund especially in our low return environment, and I do it myself but dividend paying funds/stocks are not tax efficient at all. You'd be better off with either a municipal bond fund for your state (or national if no income tax) or a more tax efficient etf. If you go the investing route its best to over fund it 10-30% in line with traditional draw downs for the asset class until it strongly outgrows it to a healthy margin of safety.

I personally have a bare bones couple months liquidity in checking, then everything else is in a taxable/emergency funds. I dont see why its such a big deal, it takes 2 secs to liquidate them if necessary. Some people also use a HELOC for such purposes as well. Lots of ways to do it.

[The White Coat Investor]

I think stocks and HELOCs make terrible emergency funds. Mine sits in an Ally bank account making 1%. The fact that it is there allows me to take significant risk with everything else. Think of the "cost" (the difference between 1% and whatever you'd get in stocks) as the cost of the insurance.

That said, do you really need such a large emergency fund? 3-6 months of expenses is the typical recommendation.

[Zaphod]

Yes I think that is a totally accurate description. Also right that I dont keep more than a couple months secondary to disability as that is the most likely probability where I would need something, so totally fair as well.

I dont think you should put that super short money and the 20k probably counts as that, which is why if you do want to invest a part of your e fund it needs to be overfunded. All likelihood is you will not use that e fund anytime soon, and it will grow significantly outgrow its starting point in a short time.

So I guess if you had to distill it down, cash for the absolute emergency fund of about 3 months, and if you feel like over funding it to feel even more secure you should consider a taxable account for that.

[retinadoc]

I think a good argument can be made for a physician to place their emergency fund in a conservative growth index fund (e.g. VSCGX), maybe even "over-saving" to at least 130% of their short-term needs as suggested by one of the Robo-advisors.

I realize that this sounds like "bull-market bravado". But, putting aside 130-150% of your needs should give you enough to last six months in almost any situation. If you are doubly unlucky (you lose your income and we are in a deep recession), you are going to sell low on the emergency fund but that is a risk that I feel is worth taking. After six months, you should be able to relocate and find new work or start receiving disability benefits.

This is not advice that would apply to those whose livelihoods are riding the crest of the economy, i.e. tech workers, auto workers, etc. At this time, physicians (their jobs, not their portfolios) are relatively insulated by these events.

[OBGYNguy]

Curious as to everyone's thoughts on CDs for this purpose? I have been reading up on a lot of them, and they seem like an option that is at least slightly better than just sitting in a savings account making 1%. GS Bank for example has 5-year CDs at 2%, and creating a "CD ladder" (read up on this, I highly recommend doing this if you're going to invest in CDs), so that you have one of your CDs up for renewal on a semi-regular basis. Why I like them for emergency funds is that there are NO FEES at all at most banks, even if you withdrawal your funds before the CD term ends (you get all of the initial deposit, and all of the interest up until that point minus 3 months usually-but varies from bank to bank). So it can truly be used in an emergency with very easy access to some or all of your money at any time. Anyone else use these? Are there some major red flags for CDs that I am missing?

[TheGipper]

My preferred eFund approach:

Tier I: Bank (BoA) checking to cover monthly credit cards and cashflow plus small buffer.

Tier II: IBonds or municipal bonds funds.  I personally use mostly Vanguard municipal index ETF (VTEB) through Merrill Edge to maintain my platinum honors status with BoA and high credit card cash back rewards.  Some might argue in favor of a shorter duration bond fund which is fine.

Tier III:  Vanguard taxable account.  If we get this far I may incur some unwanted capital gains but so be it.

I have a physician spouse and fairly good job security but also have very high monthly costs, mostly daycare and mortgage, so my 6 months EF is too much for me to stomach accepting 1% or less return.  A good argument can be made that disability insurance, SS disability, unemployment, and the ability for a physician to rapidly find other work, even if locums, may mitigate the need for the traditional 6 month EF recommendation, but to each their own.

I don't personally love the inconvenience (admittedly minor) of chasing the best online savings account yield or CD rate.

[OBGYNguy]

Questions for TheGipper: What do you mean by tiers? You allocate a certain portion to each? Also, when you say Tier III is a taxable account, that implies the second one isn't?

The ease of the fund options are definitely nice, and in your case if it is helping you achieve other account perks, then it may very well be an ideal option (though again, I have it set up so I only have to look at my CDs once a year, and even then, if I ignore them they just keep cycling through so it actually can involve no inconvenience if someone wanted), but I can't justify the unnecessary fees I'd incur by doing any sort of bond funds...

[GXA]

CDs are less liquid than an online savings account and your return is not much better.  My emergency funds are also in a high yield online savings account.

[TheGipper]

OBGYNguy wrote:

Questions for TheGipper: What do you mean by tiers? You allocate a certain portion to each? Also, when you say Tier III is a taxable account, that implies the second one isn’t?

The ease of the fund options are definitely nice, and in your case if it is helping you achieve other account perks, then it may very well be an ideal option (though again, I have it set up so I only have to look at my CDs once a year, and even then, if I ignore them they just keep cycling through so it actually can involve no inconvenience if someone wanted), but I can’t justify the unnecessary fees I’d incur by doing any sort of bond funds…

Click to expand...

1)  Yes, portions in each.

2)  Sorry, should have been more clear on tiers II/III.  Yes, tier II muni bond ETF is also in a taxable account at Merrill Edge, but I don't count it as part of my overall asset allocation.  Tier III Vanguard taxable account is invested at my desired 80/20 taxable account AA.  Should I ever need to dip into it, I'd withdraw from whatever causes me less capital gains pain, likely a combination of the muni bond component (VWUIX and VMATX) and whatever newer equity lots might have a loss or minimal long term capital gain.  When emergency is over, I'd replenish/rebalance.

The Merrill Edge dance gets me a significant bump in CC cash back bonuses, up to 5.25% gas, 3.5% groceries, Costco, Walmart and Target (coded as grocery), and unlimited 2.625% back on all other spending.  As I put everything except mortgage spending on my cards, including high daycare bills, property taxes, etc..this saves me a boatload annually, almost $5000.  The alternative for me to get the CC bonus would be transfer part of my Vanguard Roth IRA into Merrill using Vanguard ETFs, but I'd rather just keep my Roths all with Vanguard in mutual funds for simplicity sake.

Not exactly sure what you mean by the unnecessary fees for bonds.  The expense ratios on these Vanguard muni bond funds and ETFs is in the 0.12% range, which is $48/year on $40,000.  VTEB currently has an almost 1.5% SEC yield, which for me produces a tax equivalent yield of about 2.6%, which may vary slightly for you based on tax bracket and state tax.  If I factor in the $5000 saved in CC cash back, this yield is even higher.  The 2.6% beats online savings and also stands up well to even 10yr CDs, with acceptable risk as part of tier II.  A shorter term tax-exempt fund would also suffice if you want less risk or have less in tier I of your eFund.

I also like IBonds for tier II as they offer inflation hedging and state tax free growth which for me, for this purpose, is more valuable than the higher yield of a CD.  They also have no cost to purchase or hold and only a minimal forfeit of 3 months of interest if cashed in early in the first 5 years.  Finally, they can often be used federal tax free for education if your income is below the threshold level. Even if your income is too high now, it might not be in 30 years when you are retired, using it for kids grad school or even grandkids education.  You'll want some inflation protection when in retirement anyway, so why not start building your IBond portfolio now.

[OBGYNguy]

Thank you, that answered my questions.

[PenguinMD]

Thanks for the tip on the BoA Cash Rewards combo with Preferred Rewards bonus! Forgot about that card and been looking for a card for Costco, now that it's off AmEx. I'll look at applying to use for my Costco shopping .

So if I read correctly at Plt Honors level, you're maintaining north of $100k in Merril muni bonds for emergency funds? Isn't that a lot? Or you also have individual investing in there too?

Guess that amount could make sense if you have something like a $10k mortgage (ack!).

I also use muni (CA exempt) to help escape the dreaded the high marginal tax here in CA . I use Fidelity and several CA exempt munis but now I'm thinking maybe to move more to Merril so I can bump up the CC bonus, already have Plt level to get the free trades.

[Zaphod]

PenguinMD wrote:

Thanks for the tip on the BoA Cash Rewards combo with Preferred Rewards bonus! Forgot about that card and been looking for a card for Costco, now that it’s off AmEx. I’ll look at applying to use for my Costco shopping .

So if I read correctly at Plt Honors level, you’re maintaining north of $100k in Merril muni bonds for emergency funds? Isn’t that a lot? Or you also have individual investing in there too?

Guess that amount could make sense if you have something like a $10k mortgage (ack!).

I also use muni (CA exempt) to help escape the dreaded the high marginal tax here in CA . I use Fidelity and several CA exempt munis but now I’m thinking maybe to move more to Merril so I can bump up the CC bonus, already have Plt level to get the free trades.

Click to expand...

Just a clarification from another plt honors BofA Merrill Edge user, the 100k threshold is across all of your accounts. So this includes checking, savings, taxable and your 401k/etc....So it should be very easy to hit this number and its not so concentrated to one account.