Bond fund vs. MMF for EF?

[disneysteve]

What do you guys think about using a bond fund right now instead of a money market fund for some of your EF? Vanguard Prime MMF has a YTD return of 0.87%. Vanguard Total Bond Market Index has a YTD return of 2.13%. With interest rates dropping like a rock, our MMFs will be earning next to nothing.

[Merch]

I look at the purpose of the money. A bond fund can go down in value and generally do not have check writing capabilities. A true emergency fund should be kept either in a high yielding checking account or MMF.

With that said, do you think that your EF is greater then you need? In other words maybe you reduced expenses or your job is more stable and you only need 4 months instead of six? Then is makes sense to transfer the extra money to your investment portfolio (in essence just relabel that money).

I guess what I am really saying is that the EF is all about the preservation of capital and the ready access of it. But it sounds like things are more stable in you life and you think that the EF but be larger then needed.

Just my 2 cents.

[jIM_Ohio]

Did you compare to CDs?

The purpose of an EF is NOT to earn you more money. Yeah getting 5% in a money market was good in 2007 and 2006. But long term yields on money markets are less than 3%, as best I can recall.

So now people will "performance chase" yield, and then realize they put principal at risk (a bond fund will lose value if rates go up).

My suggestion- 3 months cash in something. I wasn't complaining when my CDs were paying 2.5% at end of 2007. Now that 2.5% is looking OK. Using a ladder in CDs will help you lock in rates for a short period. Then put another 3 months into a bond fund (TIPs suggested), moderate fund or similar to increase return while taking principal risk.

I would not put 100% of EF principal at risk in an effort to get more yield.

[disneysteve]

My suggestion- 3 months cash in something. I wasn't complaining when my CDs were paying 2.5% at end of 2007. Now that 2.5% is looking OK. Using a ladder in CDs will help you lock in rates for a short period. Then put another 3 months into a bond fund (TIPs suggested), moderate fund or similar to increase return while taking principal risk.

I would not put 100% of EF principal at risk in an effort to get more yield.

I didn't mean to suggest putting it all in a bond fund. Too risky for an EF. I meant just a portion. So maybe 1/3 in a MMF, 1/3 in laddered CDs and 1/3 in a bond fund, or something like that.

[jIM_Ohio]

I didn't mean to suggest putting it all in a bond fund. Too risky for an EF. I meant just a portion. So maybe 1/3 in a MMF, 1/3 in laddered CDs and 1/3 in a bond fund, or something like that.

Makes sense to a degree.

Consider- CDs will have a breaking point. Meaning if you only put in a little, you might have better choices somewhere else which make more sense for whole picture. I opened up a new CD at lunch today. There are two sweet spots at my bank:

7 month CDs (rate goes from 1.x% to 2.2%)
$5000 CDs (rate goes from 1.x% to 2.y%)

I miss both, for a few reasons.

My current interest paid is $4000*3*1.5%=$180

1) keeping 7 month CD ladder for me means tieing up 7 months expenses in CDs to earn an extra $50-$200 in interest per year (depending on rate). $4000*1.5%=$60. 7*$60=$420. vs $4000*2.2%*7=$88*7=$616
2) $5000 is more than a months expenses (might be closer to 2 months expenses). The interest difference is $4000*1.5%=$60*4=$240, vs $5000*2.1%=$105*4=$420.

I need to save an extra $16000 (4*$4000) to make an extra $436. $430/16000=2.7%. Not a good return to even consider.
I need to save an extra $3000 to earn an extra $180 in interest the other way. $180/$3000=6%

The extra 6% is tempting- add a little more to each of 3 CDs to find that sweet spot.

But I am preferring to put that extra $3000 in PRPFX (with risk to principal) to see PRPFX possibly go up 8-12%. The probability I lose money over a 1 year period is extremely low (based on past performance).

What I might do (20 years later??) is take the 4k and break it up into 2k CDs (so 3 4k CDs becomes 6 2k CDs). The ladder the 2k every 7 months and add 2k in to make a 7 month CD ladder. This would imply kids are grown, expenses have decreased and risks have decreased.

But 7 months expenses cash is a little steep when I need to be focused on growth.

[Merch]

To me, I would make your EF 1/3 of what it is now and keep it in the MMF.

I would move the other 2/3 and treated like the rest of your investments and allocate it according (some in to stocks, international, and bonds).

If you are not willing to do that then why woudl you invest it into a bond fund or ladder CDs. Bond funds have risk and you could lose money. With CDs, the money might be locked up when you need it.

With that maybe the magic number for you is 50% MMF and 50% allocated like the rest of your invesments.

Are these risks woth what 1.2% or 1.3% more return? So for every$10,000 you have you would be yielding $120 - $130 a year more. Personally, I think the risk is greater then the return.

Also, I look at the EF more as wife insurance. If my wife has a pile of cash sitting somewhere that she could get to tomorrow, she feels safer and sleeps better. This means less nagging and a happier Merch.

[jIM_Ohio]

If you are not willing to do that then why woudl you invest it into a bond fund or ladder CDs. Bond funds have risk and you could lose money. With CDs, the money might be locked up when you need it.

A CD ladder does NOT lock up the money. A CD does, a CD ladder does not.

3 reasons:

1) CD ladder implies many CDs, with staggered maturities. The staggered maturities cover forseeable withdraw dates.

2) CDs can be accessed prior to maturity and CD owner would just forfeit the interest

3) Need is relative

I define an emergency as a job loss, death or healthcare crisis. Anything less is stressful, but not an emergency.

My EF is in a 90 day CD ladder (3 -90 day CDs, maturing every 30 days, each CD has one months expenses in it).

I need 3 months cash to cover a job loss. My job pays me 2X a month and if I needed access to CDs for this reason, I would know 2-4 weeks out, because that is how much vacation I have and how much expenses are in my checking account anyway.

CDs at my bank have a 10 day period where I can "look back" and withdraw money without penalty, so in reality there is a 20 day period between when my CD matures and gets past 10 day look back, and to when next CD matures. I get paid every 15 days, so in reality there is a 5 day risk I have no income coming in when I need to pay for a bill if I lost my job.

More importantly my wife cannot access the CDs because they are NOT tied to an ATM card or electronic banking- so we have some forced discipline to discuss stressful financial situations before deeming them an emergency.

[jIM_Ohio]

Also, I look at the EF more as wife insurance. If my wife has a pile of cash sitting somewhere that she could get to tomorrow, she feels safer and sleeps better. This means less nagging and a happier Merch.

On a more humorous note, I want to know where a person can buy wife insurance. Is this similar to a mail order bride which can be returned for a full refund if all systems are not working properly?

[Merch]

i am just saying that EF and investments have different purposes and you shouldn't look to maximize return by taking on more risk.

By the way, there are banks where the APR is over 3%. HSBC Direct in NY is offering 3.05, no min, and FIDC insured. Zions Bank in Utah is offering 3.87 with check writing and FIDC insured.

These are right in line with your high yield CDs.

I would recommend a high yield saving account. No risk, access to money incase of an emergency.

As for the wife comment, I hope you were kidding. The way I read it was that your wife would drain the account if it had check writing abilities.

Source: Money Market High Yield ( MMA ) and Savings Account Rates

[Broken Arrow]

Hilarious! I thought it was a typo the first time around!

[jIM_Ohio]

I bet the decline of the dollar will make the unit cost of money market accounts dip below $1/share. Maybe, just maybe.

Flight to safety with cash right about now.

[Merch]

Wife insurance = the amount of money we have in a checking account when my wife stops worrying about the stock market and that she's going to be a bag lady.

Caution: premium differs depending on model.

[jIM_Ohio]

Wife insurance = the amount of money we have in a checking account when my wife stops worrying about the stock market and that she's going to be a bag lady.

Caution: premium differs depending on model.

Each model will have a different point of worrying. My model will worry about what cleaner I used on the toilet, what I said at the bar with the guys about so and so and also worry about anything which can be construed as "negative data".

With this model the best plan is to let the spouse do the investing, and let wife do the cleaning.

Performance does vary with the model. But I only have experience with the current model.

And If I decided to change models before disposing of current model, most models will turn out to be incompatible with me as well.

LOL

[Broken Arrow]

My goodness! I now realize what I have been doing wrong all this time! I didn't have have a wife insurance fund! A mistake that I shall never make again. Thanks SavingAdvice!

[jIM_Ohio]

when the wife empties out the checking account, that is known as wife insurance fraud.