Outside the Box: What’s the safest place for retirees to keep an emergency fund?
If you have retired from full-time work, or will soon, it’s important to have enough liquid assets to keep you from drawing down your portfolio in times of market turbulence.
Consider it the money that keeps you safe.
“It keeps you calm and steady in times of market volatility,” says Daniel Lee, director of financial planning and advice at BrightPlan, a financial wellness benefit provider based in San Jose, Calif. “The cash protects your investment portfolio from having to sell something at an unfavorable time.”
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The funds should be liquid, easy to access, and enough so you are “able to sleep at night and not have to worry about how the stock market is doing,” Lee says.
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There are actually two types of funds to help you stay financially secure: a rainy-day fund and an emergency fund, the first smaller than the second. Some experts recommend having as much as one to two years’ of expenses in cash while others suggest three months. “If you’re nearing retirement, look at increasing that,” Lee says. For example, if you have retired but not yet claimed your Social Security retirement benefits, consider having more cash available.
Yet, more than half of Americans — 51% — have less than three months’ worth of expenses in an emergency fund, according to Bankrate’s most recent 2021 Emergency Savings Survey. Further, that total includes 1 in 4 (25%) Americans who said they have no emergency fund at all, up from 21% in 2020.
During the early days of the pandemic, in March 2020, for example, when the Dow Jones Industrial Average
plummeted, emergency funds would have been especially valuable.
“With an emergency fund the whole point is if you need money, it’s there,” says certified financial planner Andrew Feldman, who is based in the Chicago area. “If unforeseen things happen in your world, we’ve got some place to go. If you are on a fixed income, you don’t necessarily anticipate one-off items.”
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And you don’t necessarily want to spend down money from equities. If you are not yet 59-1/2, taking funds from retirement accounts can trigger a costly penalty. Further, if you do, you not only spend the money for your retirement but even if you replace some of it, you have lost the benefit of compounding.
Having an emergency fund or both a rainy-day and an emergency fund can make a big difference.
Where is the best place to keep your emergency fund? High-yield savings account? Online savings account? CD? Money market? To make sure your fund is easily accessible yet reaps a decent yield, what are your best options? Yield is important, and so is security.
“Make sure that you’re getting reasonable rate,” yet remember: This part of your money is meant for security, Lee says.
Experts agree that liquidity is important. “When thinking about saving for an emergency, be as liquid as possible,” says David Sieminski, senior policy adviser in the office of community affairs at the Consumer Financial Protection Bureau. Having to sell off your investments if you need cash can mean taking a loss if the investments are down,” he says. “If you have liquid cash, you don’t have to draw down from those investments.”
He and others recommend having two separate funds in place:
An account that is fairly liquid for unexpected expenses that are short term such as an appliance or vehicle repair. This is often known as a rainy-day fund.
A second fund with relatively good liquidity with some of the funds at a higher yield for larger, unexpected expenses, such as job loss or a new roof on your home. This is known as an emergency fund.
“If you have an emergency fund and a rainy-day fund, you’re “not relying on your market investments,” Sieminski says. “Having some money set aside not in the market, it’s your safety valve.”
The national average interest on a savings account is 0.06%, according to Bankrate. High-yield savings accounts vary in annual percentage yield (APY), minimum amount required, and the way the interest is compounded but can have an APY of as high as 0.40%, 0.55%, even 0.65%. Check bankrate.com/ or depositaccounts.com/savings.
Annual percentage rate (APR) is different from APY in that the APY figures in compound interest while APR does not. According to the Federal Deposit Insurance Corporation (FDIC), the annual percentage yield “measures the total amount of interest paid on an account based on the interest rate and the frequency of compounding.”
Compound interest is interest paid on previous interest and considers how often it is compounded. Is it daily, monthly, quarterly or simply annually? The more frequently the interested is compounded, the faster your money can grow.
High-yield savings accounts typically provide flexibility yet each financial institution — whether a brick-and-mortar bank, an online bank or a credit union — offers different rates with its own terms.
Here are some questions to ask before moving forward:
Is the rate an introductory offer?
What is the minimum balance required?
What is the APY?
How is the interest compounded?
Is check writing included?
What fees, if any, are associated with the account, such as using an ATM?
How do you put money into the account and how do you withdraw it?
Is the account insured?
Most high-yield savings accounts are insured, either by the FDIC or National Credit Union Administration up to $250,000.
For those who are willing to take a little more risk, experts suggest a short-term fixed income fund. Any of the major brokerages offer them. “You will get more yield from the bond fund than from the high-yield savings account,” Lee says. It can be an exchange-traded fund (ETF) or a mutual fund, he says. For example, the rainy-day fund can be in a high-yield savings account while part of your emergency fund can be in a short-term fixed income fund, a simple bond fund. Some short-term bond funds pay a dividend as well.
Another important point to consider is how you will replenish your rainy-day and emergency funds if you end up depleting some of the money when an unforeseen situation arises. Will you replace funds through income such as from a paycheck or business you own or, if you’ve claimed your Social Security retirement benefits, will you replenish from that income? Or, will you keep your portfolio sufficiently balanced so that you can use money from a short-term bond fund to replenish the rainy-day and/or emergency fund? Some people will sell some investments at a profit and pay capital-gains tax.
“You would want to have some fixed income” in your portfolio, Feldman says. “You might have too much cash or not enough cash. Keep your assets in balance in case the market goes down 20%.”
Harriet Edleson is the author of “12 Ways to Retire on Less: Planning an Affordable Future” (Rowman & Littlefield). A former staff writer/editor/producer for AARP, she writes for The Washington Post Real Estate section.