The 3-Bucket E-Fund Approach
On the heels of publishing a podcast episode about this topic, a few readers suggested I share the same advice on the blog. It was an episode about my variation on the traditional emergency fund concept.
First, what's an emergency fund? It's a specifically designated pool of money that we keep handy for when (not if) life throws us a curveball. It's not money to be used for the new iPhone or that next vacation. This is money to be used only in the event of a red-alert event. The car breaks down, someone gets sick, the furnace goes out, we lose a job, etc.
I won't get into how much we should have in our emergency fund, as it's a personal decision and a longer discussion. However, there are two main approaches: 1) 3-6 months' worth of expenses, and 2) a set dollar amount based on what the worst possible emergency could be for your family. For our example today, let's assume this family needs a total emergency fund of $25,000.
Instead of having all $25,000 in a savings account, I like to look at it as three separate buckets. Another way to perceive it is three lines of defense.
Bucket 1: This is money we would potentially need immediately (same day). It should be kept in a savings account attached to our checking account. It may not earn interest, but we can access it at a moment's notice. This is key!
Bucket 2: This is money we would need in a matter of days. Since we have a little timing flexibility, we can house it outside our primary bank. A high-yield savings account or money market fund would work well, as it would pay you interest, give you quick access, and have zero risk. For example, Vanguard's money market fund is currently paying 5.3%, and CapitalOne's 360 Performance Savings accounts are paying 4.3%.
Bucket 3: This is money we have quick access to, but we'd also like it to grow over time. It's also money that is a nice-to-have, not a need-to-have. Why? Because it will be invested in the stock market and could experience ups and downs over time. A taxable brokerage account is perfect for this. If invested in the S&P 500 index or total stock market index, it should provide you with a long-term 9% (but a short-term bumpy ride). But either way, it's available for us to access as needed. Fidelity and Vanguard are both great places for these types of accounts.
Back to our example family (which also happens to be a real client). Here's how they decided to allocate their three buckets:
Bucket 1: $4,000 in a savings account tied to their joint checking.
Bucket 2: $10,000 in a money market fund in their Vanguard taxable brokerage account.
Bucket 3: $11,000 in VTI (total stock market index) in their Vanguard taxable brokerage account. They will also grow this account over time for multiple uses (college, retirement, cars, etc.).
Simple, but powerful. Got questions?