This week Kevin was quoted in an article examining whether or not to take a bit more risk to generate more yield for your emergency fund. Generally, I’m not a fan of taking on additional risk for funds that are truly designated to protect against emergencies. However, maximizing the yield you receive with those funds makes sense to me.
The other key point is that I frame the low-return savings situation in terms of insurance. Whether it’s an emergency fund or an insurance policy, the point is to manage our risk. In the case of an emergency fund, we’re guarding against the risk of selling growth assets, such as stocks, at a time that is unprofitable. In the current interest rate environment, yields on safe money are so low that it is painful to set aside a portion of our assets to earn so little. Nonetheless, it’s sensible to do that, and I’ve begun framing the opportunity cost of lower returns in terms of an insurance premium. We don’t hesitate to buy car insurance to protect against significant damage to our vehicles. For most of us, the expected return on the insurance premium is zero. At least, that’s the ideal. The paltry returns on our emergency savings are tough to swallow, but the savings are there to protect us in a similar manner. It’s reasonable to equate the foregone yield to an insurance premium.
Read more on the MarketWatch website: Rethink Your Emergency Savings Strategy.