Posted in Money on January 4th, 2017
Savings is probably the first step in your financial journey. Many people offer advice on ways to save money for emergencies. But, where should you keep the money? Interest rates are so low, inflation just eats up whatever you make. Also, you will still need to pay taxes on whatever you collect on interest. One of the most common recommendations is to keep emergency savings in a laddering strategy. Tim has provided several excellent alternatives and reasons why.
Emergency savings is vital to as one tries to grow wealth and financial freedom. It is always recommended by a financial advisor, but the advice varies on how much to keep and where to keep them. Generally, it is recommended to keep in accessible form, usually in a savings account. Reasons are that it is federally insured through FDIC. Also, it is more secure than keeping cash in the house. Another practical advice is to buy certificates of deposit (CD) with a laddering strategy through a financial institution.
A basic ladder consists of purchasing different maturities in equal amounts. Here’s an example found in an online bank, but it seems like they have issues with the graphics on their interactive section. This strategy is to buy equal amounts in increments of one year maturities through five years. Ideally, the five year maturity CD will accrue larger interest than the one year maturity CD.
Another popular strategy is to buy long-term CDs (12+ months) every couple of months. This way, one will have access to a portion of emergency savings every couple of months. The downside is that it will take some time to set up this strategy.
To immediately set up CDs to mature every couple of months, one would purchase various short-term maturities (3 months, 6 months, 9 months, 12 months) in equal amounts of emergency savings. For example, by dividing $10,000 of emergency savings into $2,500 and putting them into the four short-term CDs. With automatic renewals, this allows access to money every three months and need only to set up once.
Ideally, one would not have to access the money for about a year, the first matured CD (3 months) will then be converted to a 12 months CD. This will be done again for the 6 months and 9 months CDs. Now there are 4 CDs with 12 months maturity for higher yield, but a individual CD is maturing every three months. Now, one can set up an automatic renewal of the CDs if not needed. This is a bit more time consuming to set up, but once it is set up, one will have the safety of knowing that CDs can be accessed without penalty every three months, with a bit higher yield rates.
However, here are some reasons why I do not recommend this strategy:
I am not trying to deter you from using CDs for emergency savings. There are numerous ways one can implement to suit one’s needs. If CDs are within your comfort level, many on reddit (r/personalfinance) have recommended and used the strategy successfully.
Alternatives to CDs
Here on FinTekNeeks, we consult our clients to divide up savings into various assets. One of the key reasons to save is to hedge against inflation. Yes we having been harping on gold and silver. With gold and silver prices declining in the last year, I am hesitant in recommending them. However, it should represent a small portion of savings, not all of the emergency savings. Again, physical metals tend to be a hedge against inflationary central bank currency.
Another key reason to save is to facilitate growth in the economy. There are many parables about money in a great book called, “The Richest Man in Babylon” by George S. Clason. One parable talks about lending money. I perceive that the lesson in the parable is about not hoarding money, but lending to help others grow, while receiving a return on the money lent. This way, the economy gets better while the money works for you. It is not about loaning out money with high interest rates, but using the money to help build businesses and entrepreneurs. In some states, peer-to-peer lending is allowed (crowdfunded loans). There are numerous online platforms where you can lend people money for a monthly repayment, where you are acting like a bank collecting interest. However, risk is distributed by only funding a portion of the requested loan and others join in to fully fund the loan request. Also, governments have passed regulations where you can start to invest directly in companies raising funds through stock offerings. Before, this was allowed for high net worth individuals, hedge funds, and venture capitalists. It is a form of crowdfunding, but to a company, not a product or person. A word of caution, crowdfunding can easily be abused by fraud.
One option is to keep majority of the emergency savings in a stock brokerage account. Here are reasons why I like to keep emergency savings in a trade account.
With Tim’s previous post on saving for retirement, we have provided you with options that you can choose that best fits you. We wish you much success and growth in the new year 2017.