Earn interest while keeping your emergency fund fluid.
As you work your way towards financial freedom, it is imperative to have liquid assets. The most liquid of all assets of course is always cash. Having stocks in a brokerage account is dandy, but the turnaround time to sell them can be days until the funds are transferred into your bank account. This is no good if you have a situation arise which requires immediate funds.
Because life happens, having an emergency cash supply is essential. The ideal emergency fund is to have two years worth of living expenses stashed away. It sounds like an excessive amount, but believe me it is achievable. It just takes time to reach that level.
Two years worth of living expenses for most people is measured in tens of thousands of dollars. So for argument’s sake, let’s assume the amount we are discussing is between $25,000 and $50,000. Keeping that amount of money liquid can be a tricky matter, but you should not sacrifice the chance to earn interest on as much of your emergency fund as possible. There are ways of earning varying amounts of interest while still keeping your assets accessible.
The first and most important thing I recommend is always having $1000 physically on hand in your home. Keep it hidden of course, but have it! You’ll never earn interest on this smallest part of your emergency fund, but it is worth the small sacrifice to be able to reach out and touch your money if you need it in seconds. It is better to have a $1000 in cash on hand you don’t need, than to need $1000 you don’t have. Again, this is EMERGENCY MONEY, not fun money. If it’s not a matter of life and death, DON’T TOUCH IT! DON’T EVEN LOOK AT IT!
Next, keep between $2000 and $5000 in your savings account. There are still some banks that will offer a minimal amount of interest with no fees. Often times credit unions will offer better interest than banks. Usually keeping $5000 in either a saving or money market account will earn you a higher interest rate for your cash. You can shop for the best interest rates offered at www.bankrate.com
Certificates of Deposit or CDs offer better interest rates but they tie up your funds until the maturity date. The longer the term, the higher the interest rate. Typically the terms run from as little as 3 months to as long as 5 years. To take advantage of the best interest rates while still keeping the cash fluid, I would recommend using a CD laddering strategy. Distribute your next $5000 to $10000 into a varying number of CDs each having different terms and end dates. You can create a ladder of CDs as long as you like with each CD being a rung. As each rung matures you can access it without penalty, or roll it over and wait for the next rung in the ladder to mature.
EX: Using $10,000, divvy it up into:
- 5 year CD $5000
- 2 year CD $2000
- 1 year CD $1000
- 6 month CD $1000
- 3 month $1000
With the CD ladder in this example, you will have a minimum of $1000 available to you every 3 months, and a minimum of $2000 every 6 months which you can cash in without penalty should you need it. Or let it roll over and continue to accrue interest.
Any part of your remaining cash assets beyond the above suggested $16,000 of allocated funds should be kept in a brokerage account such as MerrillEdge or TD Ameritrade to be used for the purchase of dividend stocks. By investing in a diversified portfolio of various dividend paying stocks, you will be able to hedge your bets while maintaining a return on your investments. You’ll have to do your own homework on which stocks to buy, as past performance does not guarantee future earnings.
When you have two years worth of living expenses under your belt, you can afford to use any additional ‘mad money’ you may have for more risky financial ventures. Some suggestions could include:
- Collectibles / art
- Real estate
- Starting a business
- Financing peer-to-peer loans through Prosper.com
Again, these are just suggestions and not recommendations. Ultimately you have to decide your financial future, but if you fail to plan for your future, you won’t have one. As always I wish you happiness and success.