By this stage of your life, you have all heard the sage advice to save money for an emergency fund. Most financial articles and planners advocate keeping between six to twelve months of after-tax income in a money market or similar cash equivalent account.
Emergency money provides a safety cushion to absorb the unexpected surprises of life. Preservation and liquidity of these funds are of paramount importance. You must be able to access your money immediately when needed. But liquidity and preservation requires purchasing low risk investments…extremely low risk. This translates to accepting low returns…extremely low returns.
In today's economy, keeping cash in money market funds will yield a paltry 1.5%. Checking and savings accounts barely return half that, or 0.75%. Clearly returns on cash savings are limited. A sudden return of inflation to our economy and your emergency stash could actually lose value.
What's a prudent investor to do? Think-outside-the-box as platitudes go…or metaphorically, climb the ladder to success. “Bond ladders" describe the purchase of multiple bonds with staggered maturities. This purchase strategy minimizes interest rate risk and smoothes cash flow.
But laddering can be used for more than just controlling interest rate risk. Savvy investors use bond ladders to substantially increase the liquidity of higher yielding investments. I-Bonds are a perfect vehicle for such a strategy. I-Bonds are a relatively new savings bond issued and backed by the U. S. Treasury. Your money is 100% safe and currently earns 3.39% (twice the rate of six month CDs)!
But here's the catch: I-Bonds can not be sold for one full year after purchase. Investing your entire emergency fund would tie up your money for an entire year. Not exactly the liquidity you need. This is where laddering can help.
Invest just 10% of your money in I-Bonds. This still leaves 90% of your money immediately available from a savings or money market account. One year from now, invest another 10% in I-Bonds. This leaves just 80% in your savings account. But wait. Your first I-Bond is now one year old and can be cashed at any time. You still have immediate access to 90% of your cash in any time of need. Once each year, invest just 10% of your money in I-Bonds without ever losing immediate liquidity of your emergency funds. All while earning a substantially larger rate of return, protected against inflation, and guaranteed by the U. S. government.
WHAT ARE I-Bonds?
I-Bonds are a new liquid savings bond backed by the U. S. Government. While you own them, they earn interest and protect your savings from inflation. I-Bonds can be purchased and sold online at the US Treasury's website, Treasury Direct. www.SavingsBonds. gov
There are never any transaction or processing fees from Treasury Direct and you can easily and securely transfer funds from your bank account for the purchase of any bond. I-Bonds can be sold anytime after 12 months. You receive the original purchase price plus interest earnings. I-Bonds sold within the first five years will forfeit three months interest. For more information on I-Bonds, visit Treasury Direct.
Mr. Olson is the editor of The Asset Advisor, a financial investment service providing proven strategies for no-load mutual fund investors. He brings 26 years of education and experience from Stanford University, Ernst & Young financial consulting, personal wealth management, and venture capital investing.Subscribe to our free newsletter