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Emergency Fund Account: Money Market or High Yield Savings?
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What is the most important thing about emergency funds? Capital preservation. Your emergency fund is supposed to be the foundation onto which the rest of your personal finance house is built upon and it’s not something that should be meddled with unnecessarily. You should pour it, let it sit, and hopefully never have to touch it. However, if you ever find yourself in a situation where you’ll need it, you want it to be there just as you had left it. That being said, a friend recently asked me if I ever thought about putting my emergency funds into a money market account or if a high yield savings account is better.
Money Market Deposit Accounts (MMDA)
For those who aren’t familiar with money market deposit accounts, they are basically savings accounts where the bank has greater discretion in terms of what it can invest in. In return for this greater flexibility, the banks often will give you higher interest rates but may demand that you give them at least 7 days notice before withdrawals (Federal Reserve Regulation D).
- Principal is safe.
- Interest rate is higher than regular savings.
- Potential 7 day lag in accessing funds.
High Yield Savings Accounts
ING Direct, the high yield savings account that I believe has been around the longest, is offering 4.20% APY on their online savings accounts. Comparatively, Bank of America’s Balance Rewards Money market savings account’s highest APY is only 3.05% and that’s if you have over two and a half million dollars in your money market savings account. BoA’s money market account likely isn’t the highest around but it’s not even within spitting distance of ING’s 4.20% rate for nothing (and ING isn’t the highest rate around either!).
- Principal is safe.
- Interest rate is higher than regular savings.
- 4-5 day lag in transferring funds from high yield savings to your bank
Money Market Mutual Funds
A money market deposit account may be confused with an actual money market mutual fund, which is a wholly different animal. A money market mutual fund is like any other mutual fund with its own risk and return profile. You might be offered a higher rate of return but in this particular case you have no guarantee on your principal. If things go south in whatever the fund invests in, like in any mutual fund, your emergency fund could find itself depleted. I would not invest my emergency fund in anything that doesn’t guarantee my principal.
However, let’s say you wanted to take the risk, what are the returns like? Vanguard’s Federal Money Market fund, just to take a random example, currently has a yield of 4.69% and an expense ratio of 0.24%. So, even if we ignore the expense ratio and look strictly at the yield, you’re talking 4.69% versus a 4.20% at 100% safe ING Direct. Half a percent isn’t worth it for me to open an account, transfer money, and take the risk.
- Principal is not safe.
- Interest rate is higher than regular savings.
- Lag if you don’t have checkwriting rights.
Summary
Put part of your emergency fund in a high yield savings account, keep some reserve in a local bank so you can get to it ASAP. I don’t know why anyone would have any funds in a money market deposit account given current high yield interest rates. I also don’t know why anyone would put their emergency fund in a mutual fund, money market or otherwise, because of the risk, even if it’s low, you could lose your principal. We’re in a strange place now where high yield online savings accounts are giving such great returns and all these traditional products, like MMDA’s, are really not worth it anymore.
Where do you put your emergency savings and why?
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When looking at a Money Market Mutual Fund’s Yield, that’s already after having taken the expenses into account, so that’s actually the yield that it has.
My emergency fund is with the rest of my liquid funds in a Rewards Checking Account with my local bank that offers 6.01% APY as long as you use their debit card 10 times a month (which I tend to do with small convience store purchases like milk plus buying $1 of gas on the debit card and then using my credit card to fill up the rest of the tank).
We use ING Direct for our emergency fund. We had considered switching for a higher interest rate, but the customer service that ING provides is second to none. I have never had a better experience with a bank than I have with ING Direct.
Four thoughts:
If you already have a brokerage and/or mutual fund account with someone, opening up a money market account is trivial. With Vanguard (where I have a money market account) if you are already a customer you can open and fund one today in 5 minutes, tops.
If you have a money market fund inside a mutual fund account, you can stash excess cash there and earn a return without having to transfer it between institutions. This can double as an emergency fund, making it easier than having a savings account at ING.
Most money market accounts allow check writing, so they are every bit as easy to access as anything else (just cash a check at your bank).
While technically the money isn’t guaranteed, can you think of any money market fund that has broken the buck? I didn’t think so.
Conclusion: a money market fund in a brokerage/mutual fund account you already have gives you every bit the yield (or more) than an ING savings account, with easier access to your money (can you write checks on a savings account?–I don’t know) with all the security and fewer headaches.
To answer the question, I keep minimal funds in my checking account, a slug in my Vanguard money market account at 5.3% (pre-tax equivalent yield). I wrote a check on that account for the downpayment for my house and had the money in 2 minutes. Seemed easy enough to me.
And in my third post showing the above is not good advice, I’ll link to a story that states that at most (as of 2003, granted) only one company has ever, EVER, had a money market account not pay out $1 a share.
“This could happen if some of the fund’s investments blew up. In the past, a few funds have suffered losses that threatened to drive their share prices below $1. But in each case (except possibly one), the fund company reimbursed the fund so it didn’t break the buck.”
http://www.sfgate.com/cgi-bin/article.cgi?file=/chronicle/archive/2003/06/26/BU200993.DTL&type=business
Basically, opening up a low yielding, new restrictive account to protect you from a risk that doesn’t exist, is not smart. If you have a mutual fund account, pick a high yielding, high quality money market account and use it as your emergency/random short-term savings fund.
If you have been following the news, several institutions have had to step in to keep the NAV of their money market funds at $1.00. In the current financial climate, more of this can be expected. In theory, you could be wiped out (become an unsecured creditor) if your fund goes under.
Conversely, several of the FDIC insured banks that offer high yield money market accounts could become insolvent and go under. Not many banks were taken over by the FDIC in the last few years, but that is about to change. When the bank is taken over, the FDIC will return your principal, but it may take months or years. You do not get access to your money during the process.
I keep emergency funds in three places, and the size and immediacy of a given expenditure determines the source of funds. Day to day expenditures come from Wells Fargo checking. Wells Fargo pays minimal interest, but they are a conservative institution, and are not likely to shut down unless the entire banking system fails. I keep some additional money in ING’s Electric Orange at 3.50 percent. That unexpected $1000 car repair could come from this account via the debit card. I keep a larger amount in GMAC Bank’s insured money market, which is currently at 4.50 percent. This bank carries a higher risk because of its mortgage exposure, but they offer check writing and I believe they offer an ATM card. Transfers are quick (24 hours) and easy and the monthly statements come in the mail and are easy to follow. They offer some of the better short term CD rates as well. This would pay for the larger ($5000 plus) emergencies.
Cash in the brokerage account and other savings accounts/CD’s are not included in my emergency calculations, but are available for those “once in a lifetime” emergencies.
In summary, in the current financial climate, it’s a good idea to have your cash diversified and tiered. Flexibility and insurance are as important as yield today because of the risks.
“If you have been following the news, several institutions have had to step in to keep the NAV of their money market funds at $1.00.”
That’s what I’m saying. They company will do everything to keep from breaking the buck. If the company itself goes under, you are not an unsecured creditor. You are secured by the value of the fund you hold.
My emergency fund is in an MMDA. The seven days doesn’t bother me because I live under the thought that any emergency can be taken care of with the credit card and paid off when it’s due from the emergency fund. I have a small amount in my savings account hooked up to my cash card to tide me over, if cash were necessary.
(This thought process won’t work for everyone–I have no credit card debt, so I don’t fear getting in trouble with it.)
Additionally, you are secured to the value of your fund through the SIPC (in case you are worried about your fund management firm stealing your money).
A mutual fund isn’t protected by anything for investment losses, the SIPC only protects you against fraud. Your principal in that fund is NOT protected in the event the bank goes under because it made some bad bets, that’s a huge misconception. That’s why you’ll see disclaimers like this one from Vanguard:
The performance data shown represent past performance, which is not a guarantee of future results. Investment returns and principal value will fluctuate, so that investors’ shares, when sold, may be worth more or less than their original cost. Current performance may be lower or higher than the performance data cited. To view performance data current to the most recent month-end, view Fund Watch details. Click a fund name to view standardized returns and expense ratio information.
I have my emergency fund over at E-TRADE which is sitting at a little over 5% interest at the moment. It is insured so I could care less about their negative news headlines. It just means they are giving 25 dollars to new savings customers and raising their interest rates to retain the ones they have like me.
The downside to E-TRADE though is their customer service which is horrid. Being a frugal cheapster I called them yesterday and let them know I had opened a savings account a few weeks ago. I wanted the 25 bucks they were paying for new sign-ups. They sent me to India and the ignorant person there first denied the deal and then said I had to have an IRA with them to qualify. I hung up on her and called back. The next Indian could not access the E-TRADE website to view the ad.
I finally got sent to “the man” an American business manager and he got me the twenty bucks in two minutes.
Sorry for making my own blog post here but just wanted to let you know that E-TRADE online and their benefits are top notch but customer service tanks.
What kind of emergencies could you envision arising that would require large amounts of cash in less than 7 days?
I would think that those with no or low credit probably also do not have large emergency reserves.
“that’s a huge misconception”
Actually I wasn’t misconceiving anything. My comment was in response to someone saying you are an unsecured creditor in the case of your fund management firm going under (quite different from a fund losing money, I might add). If you are concerned that in such a situation the firm (or a creditor) will grab the fund’s assets, the SIPC protects you. I made no reference at all the saying the SIPC preserves the value of your investment and feel insulted you would think anything of the sort. I’m trying to help people here.
In reality, no management firm will ever let their money market funds break the buck. That is why you’ve seen people actually pump money into the funds to maintain the levels. They aren’t legally bound to, but they do it when they need to.
Look, money market funds are the best short-term holder of cash. If you are so scared about an occurrence that never has and never will happen, perhaps the mattress is the right place for your cash.
I have mine split among different types of accounts: laddered cd’s, MMA, and high yield savings accounts. since my cd’s are locked in and laddered they are the least liquid, but i’m not going to need all 6 months in the first month.
i am moving everything from my high yield savings at Igobanking to my USAA Asset Management Account (AMA) rather than opening up a different high yield savings account. Igobanking just lowered to 4.9% from 5.05%, and my trigger for moving was 5%. I just realized that the USAA AMA gives the current MM yield of 4.9% in addition to tiered regular interest of up to 4.5% on a certain percentage of the deposits in the AMA. don’t know how they calculate (just sent off an email), but it appears that I am gaining more by putting my liquid money there. plus i get .5% every time i use the debit card, and I have unlimited check writing.
I’m with Kurt. Make a responsible choice of MMMF and you won’t have any problem. That and pure convenience make it superior to bank accounts.
I think there is one good reason for someone to hold money market fund: taxes. For high income folks in high income states being to be invest a muni money market fun can mean much higher realized return in comparison to even some of the best high yield savings accounts. Of course you need to shop around, and many times the best muni money market funds aren’t even available to most pedestrians investors – such is life for the main street investor.
Dong,
For those in non-tax states (such as Texas) the tax free federal money market account from Vanguard is an excellent choice.
State Bank of Toledo FTW! 6.01% uncapped….end of story!
I like the ING Orange Checking for my primary emergency fund. With a debit card, you have immediate access to your money when you need it. You can also easily transfer money if you have an ‘emergency’ you can plan ahead for. I stopped using the savings account at my local bank because the interest rate was a joke.
I would suggest avoiding money market funds except for those that invest only in US Treasuries or US government obligations. I’ve been looking at what some money market funds hold and it is scary. Many of them are in questionable mortgage-backed securities rated Alt-A (often no-doc/low-doc mortgages) or worse. While it is true that money market fund sponsors have been pouring money into their money market funds whenever there’s trouble in order to avoid breaking the buck, GE recently broke the buck in its Asset Management money market fund. I think that’s a harbinger of more money market fund problem ahead. I have greatly reduced my holdings in money market funds this year, moving cash into treasury-only funds and FDIC-insured high-yield savings accounts where possible.
When GE is prepared to break the buck, given their hugely deep pockets, we know there is SERIOUS trouble on the horizon. I choose to play it safe, following the advice of this blog post, and only keep my emergency fund in an FDIC-insured high-yield savings account.
To “Long Time Reader” re: the FDIC taking months or years to return the principal to the customer of a failed bank — I read in the Wall Street Journal about a week ago that in fact, the response time is more like a few days. The customers of that failed bank are able to go to any other FDIC-insured bank and open up an account there, into which the FDIC returns their funds.
http://blogs.wsj.com/marketbeat/2007/11/12/fdic-mythbusters/
The bulk of our emergency savings is now in a liquid CD at a brick and mortar bank. We are sacrificing 1.5-2% APR compared to a high-yield online savings account, but as I blogged about when I first opened the liquid CD, a big part of the equation is convenience and simplicity for my husband in case something were to happen to me. If I were single, the bulk of my emergency fund would be in an online account, no question.
From what I can tell, the GE fund referenced above is a short-term bond fund, not a money market fund. There is a real difference between the two. Anyway, if your tax bracket is high enough, a tax-free fund is the way to go, and it doesn’t invest in crazy mortgage-backed securities (as those wouldn’t be tax-free).
You didn’t mention banks that offer high yield online savings. I bank with Wamu (again not the greatest bank but hey, it’s free) amd I have their online 4.75% savings linked to my checking. It’s totally free with no minimums.
Even though my savings account is an online one, I can do everything with it like a normal savings. I can walk into the bank and make deposits and withdrawals, I can also bank online and tranfer money from savings into checking instantly–there is no wait to access the funds. The only online part is that the statements are done online vs. being put in the regular mail.
I also bank with Union Bank of CA and they were offering 5% in their savings for free if the balance is over 5K. Overall though, Wamu’s is better since you only need a dollar to open.
What is your opinion on this? I just opened a checking account called “ultimate checking” at a local bank. It pays 6.01 interest. Again, this is just a checking account. Obviously, there are some caveats to the program. Although it is a local brick and mortar bank, and you can write checks, it is mostly an online program.
You must make 10 debitcard transactions per month. You also must have one direct deposit per billing cycle OR auto draft (easy since my work check is direct deposited). Must have valid email address. Lastly, must recieve all your statements electronically. You cannot exceed $25,000 in the account.
That is all there is to it. No fees. The only concern I have is making sure I do the 10 debits per billing cycle. Hope I can remember to do it.
What do you all think about this? Is it a good deal? I think so… You can take a look at it on thier website at bankoflittlerock.com
I personally put my emergency fund in a high yield savings account with HSBC. With the federal rate cuts, I’ve been shopping around to ensure I’m still getting the best rates. You may want to check out this site for a comparison of many of the high yield savings accounts and their rates as of 1/26/08:
http://themoneykings.com/blog/comparison_of_high_interest_savings_account_rates