Making Cents - The best place to keep your emergency fund

ABOUT €10.05, that’s the amount my emergency fund made last year, was what one person told me recently. They saved hard to get to the amount they needed which was €15,000 and there was great satisfaction when they did and rightly so.

Now they were more comfortable with their job security and whilst they weren’t becoming complacent about it either because they knew redundancy or an illness could happen at any time, they didn’t think they would need access to this money any time soon, at least they hoped they wouldn’t.

Which is why they were wondering could they do something different with their emergency fund and put it somewhere else into something sensible, where it would earn more than €10 each year.
They’ve put in the heavy lifting but now they feel as if they’re wasting the amount it can grow by if they keep it in a savings account. And they’re not wrong.

However before I continue and tell you what my advice to them was, let me first very quickly tell you what an emergency fund is and why you need one because it's often overlooked.

It’s an account where you save and place money into that will help cover and pay for sudden unforeseen events happening like an unexpected redundancy, car or home repairs that aren’t covered by insurance, washing machine packs in, four new tyres etc. So, it’s meant to protect you and your family from unexpected expenses that could lead to financial hardship if you’re not prepared.

And financial advisors will typically suggest that people keep at least three to six months of their net monthly income in their emergency fund but these multiples could be higher, it will really depend on someone circumstances i.e. a self-employed person whose income is more irregular might be best advised to keep as much as nine months of their income in their emergency fund.

And your emergency fund is money I believe that should be set apart from any other accounts you have, it's a standalone account.

Anyway, back to the question that was asked of me and that was where was the best place someone could put their €15,000 emergency fund into, where it would hold its value and where it would earn some money as well? And just to let you know because I forgot to tell you, €15,000 was about four months of their monthly income.

Okay, the ideal scenario for their emergency fund and anyone else’s for that matter is where; It’s accessible if you need access to it quickly, the capital is 100% protected and the interest rate is earning enough that it’s at least keeping up with inflation so it at least holds its value.

And on that last point if the account your emergency money is in isn’t earning say 1.5% (I’m going to use that number as it’s about the current rate of inflation) then in real terms it's going down in value which begs the question, should you invest your emergency fund?

This is a question you need to consider carefully because if you do the obvious upside is that it could earn a whole lot more in interest. And people are well aware of this because they’ve seen how well markets have performed this year i.e. the S&P 500 is up about 23% year to date.

But that’s not always going to be the case and if we look at the same index in 2022, it was -18.11%.
So, investing money into markets like this has a double edged sword i.e. it can go up and it can go down. And when you invest in equities or track indices like the S&P 500 your capital has a 0% capital guarantee.

If the person I met invested €15,000 at the beginning of this year in an investment account that tracks the S&P500 they would have made €3,450 before taxes. And if they invested €15,000 at the beginning of 2022 they would have lost €2,716 which would have meant they lost about three weeks of their emergency fund.

The problem with investing in equities and market indices is that they can dip at any given time, which can create a problem if they happen to fall at the same time you need the money.

Imagine how you’d feel if the market began to nosedive and at the same time you’re given notice that your job is at risk and you look at your emergency fund balance and see it’s worth a third less than what it was before the market began to fall.

Having said that over time investing in equity based accounts or tracking stock markets indices will outperform basic deposit and savings accounts and outperform them by some margin at that, but the unknown of course is when an emergency strikes.

It could strike as I just said when markets are down and when your fund is down and you don’t have time for it to recover because you need the money now. And that’s the trouble with investing your emergency fund which is why I would err on the cautious side where the capital guarantee trumps all other considerations.

You don’t want to worry about what’s happening with your emergency money particularly when markets are going down. You want the sleep well account knowing that your money is safe and all of it will be there when you need it but it does need to hold its value nonetheless and leaving it in an account where its earning 0.10% or 0.25% isn’t going to do that for you.

So as I see it you have two options and they are:

Find an account that is earning at a minimum 1.5% net where the capital is guaranteed and you have immediate access to it. And does that account exist? It does.

I found three accounts very quickly on The Competition and Consumer Protection Commission’s website where you can compare what rates are on offer from the various providers and the website is www.ccpc.ie.

If you search like I did you’ll find that bunq.com are offering a gross rate of 3.36%, and raisin.ie have access to banks who are offering between 3.16% and 3.25% on accounts called, demand deposit easy access.

The second option is:

Invest part of your emergency fund in an equity based account

You could choose a hybrid approach where say 80% of your emergency fund is in one of those 100% capital guaranteed accounts I just referred to and invest 20% in an equity based account that doesn’t carry any explicit capital guarantee.

By doing this, you have the peace of mind knowing that the majority of your funds are capital guaranteed earning a rate that is at least matching or beating inflation and the remaining 20% is invested in accounts that could earn seven times more than what you’d get on deposit and if it earned seven times less, at least you’ve kept your loss low relative to the total amount you have set aside for emergency purposes.

And whether you invest some or all or none of your emergency fund is a personal decision that you should consider carefully because investments can be risky but they can also be very rewarding so I’d say get advice and take your time when making a decision like this. And what’s good and works for someone else may not be the right way for you and that’s okay as well.

And just to state the obvious but I will anyway, it’s never a good idea to keep your emergency money at home under your mattress or in your wardrobe or whatever you’d choose to hide it because you’re missing out on two important things (a) protection of your money against theft and (b) the potential to earn interest because what’s 100% sure is that if you keep it at home in cash you’re earning and will always earn 0%.

And let me leave you with one last thought about emergency funds and this is aimed at people who don’t have one. The best advice I’ve ever heard about emergency funds is that the best time to build one is when you don’t have an emergency, not when you’re in the middle of one.

The motivation to build one is that you’ll have more control and more peace of mind should something unexpected happen. And I’d say whilst you're building the fund, worry less about the interest and more about the amount you save each month because that’s what’s going to get you to the amount you need, not the interest rate.

Liam Croke is MD of Harmonics Financial Ltd, based in Plassey. He can be contacted at liam@harmonics.ie or www.harmonics.ie