I was looking at various advices regarding safety net and emergency fund.

  • Usually most sites recommend using the savings account and CDs as a safety net. As CDs/Savings are FDIC insured it's 'safe option'.
  • Betterment advice seems to be 'majority in bonds'. This seems to make sense as APR of bonds is higher then CDs and they don't loose due to inflation. Stocks, in long term, earn money so the account should be refinancing by itself. However it may loose money due to interest rate changes and market movements.
  • There are also those who consider a Roth IRA as a safety net though mixing safety net and retirement does seems to mix purposes.

While I consider my situation stable I would prefer to have some safety net (especially thinking long-term). Does it make sense to keep my current 3-months-spending in cash (savings account) - building it up to 6 months - while trying to build beyond that by bonds/stocks ETFs as recommended by Betterment? Or is the betterment advice somehow flawed?


The answer to your question depends very much on your definition of "long-term".

Because let's make something clear: an investment horizon of three to six months is not long term. And you need to consider the length of time from when an "emergency" develops until you will need to tap into the money. Emergencies almost by definition are unplanned.

When talking about investment risk, the real word that should be used is volatility. Stocks aren't inherently riskier than bonds issued by the same company. They are likely to be a more volatile instrument, however. This means that while stocks can easily gain 15-20 percent or more in a year if you are lucky (as a holder), they can also easily lose just as much (which is good if you are looking to buy, unless the loss is precipitated by significantly weaker fundamentals such as earning lookout). Most of the time stocks rebound and regain lost valuation, but this can take some time. If you have to sell during that period, then you lose money.

The purpose of an emergency fund is generally to be liquid, easily accessible without penalties, stable in value, and provide a cushion against potentially large, unplanned expenses. If you live on your own, have good insurance, rent your home, don't have any major household (or other) items that might break and require immediate replacement or repair, then just looking at your emergency fund in terms of months of normal outlay makes sense. If you own your home, have dependents, lack insurance and have major possessions which you need, then you need to factor those risks into deciding how large an emergency fund you might need, and perhaps consider not just normal outlays but also some exceptional situations. What if the refrigerator and water heater breaks down at the same time that something breaks a few windows, for example? What if you also need to make an emergency trip near the same time because a relative becomes seriously ill?

Notice that the purpose of the emergency fund is specifically not to generate significant interest or dividend income. Since it needs to be stable in value (not depreciate) and liquid, an emergency fund will tend towards lower-risk and thus lower-yield investments, the extreme being cash or the for many more practical option of a savings account.

Account forms geared toward retirement savings tend to not be particularly liquid. Sure, you can usually swap out one investment vehicle for another, but you can't easily withdraw your money without significant penalties if at all.

Bonds are generally more stable in value than stocks, which is a good thing for a longer-term portion of an emergency fund. Just make sure that you are able to withdraw the money with short notice without significant penalties, and pick bonds issued by stable companies (or a fund of investment-grade bonds). However, in the present investment climate, this means that you are looking at returns not significantly better than those of a high-yield savings account while taking on a certain amount of additional risk. Bonds today can easily have a place if you have to pick some form of investment vehicle, but if you have the option of keeping the cash in a high-yield savings account, that might actually be a better option.

Any stock market investments should be seen as investments rather than a safety net. Hopefully they will grow over time, but it is perfectly possible that they will lose value. If what triggers your financial emergency is anything more than local, it is certainly possible to have that same trigger cause a decline in the stock market. Money that you need for regular expenses, even unplanned ones, should not be in investments.

Thus, you first decide how large an emergency fund you need based on your particular situation. Then, you build up that amount of money in a savings vehicle rather than an investment vehicle. Once you have the emergency fund in savings, then by all means continue to put the same amount of money into investments instead. Just make sure to, if you tap into the emergency fund, replenish it as quickly as possible.


I am understanding the OP to mean that this is for an emergency fund savings account meant to cover 3 to 6 months of living expenses, not a 3-6 month investment horizon.

Assuming this is the case, I would recommend keeping these funds in a Money Market account and not in an investment-grade bond fund for three reasons:

  1. Risk of Loss. This type of fund is not an investment on which you plan to make money, it is a hedge or moat intended to protect you from unplanned bad outcomes. The fact that you might need to tap into these funds in the first place means that everything is going the wrong direction for you financially, you don't want to run the additional risk of having to pull the money out of the market at a bad time.
  2. Liquidity. When you have a real emergency, you need your money NOW. You can usually write a limited number of checks out of a money market account, but not out of a low-cost brokerage account.
  3. Insignificant additional returns. Let's assume you maintain an emergency fund of $30,000.00 USD. If you can get an additional 1% real return in the bond market, you've made an additional $1.00 per day before taxes (so maybe $0.75 in reality) by putting your money at risk in the market.
  • As for the 3-6 months "investment horizon", consider the following example (extreme example for proper effect). You have six months or so of living expenses in the stock market (long term investment horizon) as your emergency fund, and nothing else. The economy tanks causing you to lose your job, and takes the broad stock market along with it. Soon after, and before you land a new job, your car needs some expensive repair, and a faraway relative becomes seriously ill. You have had no time to reallocate to "safe" investments. The investment horizon counts from the start of your bad situation.
    – user
    Nov 25 '14 at 8:24
  • I may not have been clear, but my point is that 3-6 months is too short to be an appropriate time frame for a true investment when the focus is on emergency funds or capital preservation (such as what to do with money you need for a down payment, etc.).
    – JAGAnalyst
    Dec 1 '14 at 16:19

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