I look at buying short-term Treasury bill funds and compare them to a high-yield savings account to see if the returns are worth the risk.
Emergency funds are simple.
You don’t need to do much with them. The best place for money that’s serving as an emergency fund is in an account that’s liquid, meaning that you can access the money when you want, without penalty. If you are needing to tap your emergency fund, then by definition, you are dealing with some form of life penalty, so adding a financial penalty isn’t helpful, and may make you reticent to use your funds when you need them.
(Not sure if something’s an emergency? Here’s how to determine that.)
Because of all this, the place for your emergency fund isn’t the stock market, or your retirement account. It isn’t the same thing as a 401(k).
So what I’ve done for years is to store my emergency fund in a savings account. Not just any savings account, but a high-yield savings account. Whereas a big bank might offer 0.01%, a brief search online can net you 3-4% (at the time of writing). It fluctuates, of course, but it will always be better than 0.01%.
You won’t earn stock market returns of 8-10% with this method, but then again, you will never lose money either. And with an emergency fund, that’s key.
So that’s the end of the story, right? Have money, put in savings, forget about it.
Or is it?
Because in this economy, every percentage of return counts, and there may, possibly, be a way to increase your returns while keeping things safe.
Short-term Treasury bills
You could buy U.S. government debt, meaning short-term Treasury bills.
Wait, hear me out.
There exist funds at major brokerages like Vanguard and Fidelity, that purchase short term Treasury bills over long haul. These funds have returns that are roughly the same as high-yield savings accounts, sometimes higher.
Comparing with a savings account
Take a look at this Vanguard fund, called “Vanguard Treasury Money Market Fund” and with the ticker VUSXX:
(Note that there are many such options and not all at Vanguard. There’s Fidelity’s Treasury Only Money Market Fund or FDLXX, Schwab’s U.S. Treasury Money Fund or SNSXX, and probably plenty of others. I’m just giving one example here.)
Over the last three years, it’s returned 13.48%, which is an average annual return of 4.31%. Not bad.
Now, I’ve long used Ally for my savings accounts. I recommend them because I know them, but I’m sure there are plenty of other good options too. I’ll use them as my example.
Ally doesn’t publish a record of its returns, but I do keep my own records, and over the last three years, it’s fluctuated between 3% and 4.35% (mainly going down).
So already, you can see that the fund wins out, and by somewhere in the ball park of 0.5% to 1%.
The state tax penalty
The above sounds okay, but it doesn’t totally pass my 1% rule, which states that you generally don’t want to move your money unless it would net you at least 1% or more in return. Otherwise, the benefits don’t outweigh the administrative hassle.
But we have to talk about taxes, specifically state taxes.
That’s because, with a savings account, you have to pay income tax on your returns, for both federal and state taxes.
This can add up. Say you’re in a 24% tax bracket with a 9% tax bracket for state. That’s 33% in taxes on your earned money.
But Treasury bills? You don’t have to pay state tax on them. And the part of a fund with Treasury bills (with in this case is 100% of the fun) therefore doesn’t require that you pay state taxes on the returns either.
Why is this? Government obligations like bonds are not subject to state taxes. Hey, now you know.
And so the returns that you earn from these Treasury bills are taxed at 24% instead of 33% (given the above example). In high tax states, at high balances, that can add up.
The state tax savings
Let’s say that you earned the above 4.3% on your money. Now let’s say you had $50,000 in your emergency fund. That’s $2,150 in returns for a year. Bravo.
When you go to pay taxes, using the 24%/9% example from above, you’re paying $710 in taxes, so your return really was more like $1,440, or 2.8%.
Now, if you didn’t have to pay state taxes, you’re only paying $516 in taxes, so your return goes up to $1,634, or 3.2%.
The difference between 2.8% and 3.2% is a 14% higher return.
The point here is: If you live in a high tax state, buying a Treasury bill fund can net you more money in return when compared to a standard savings account, even when the equivalent rates are the same.
Risk
But we have to talk about risk.
A savings account is FDIC insured, so if the bank fails, you’ve got protection up to $250,000. In short, you’re never losing your money.
A mutual fund at a brokerage, like this VUSXX fund we’ve been talking about, is not FDIC insured. So technically, you could lose money.
But will you? Losing money here is the equivalent of the U.S. defaulting on its debt, which would be a catastrophic event for the entire world. Not even the people in MAGA Land want that to happen, I don’t think.
This is the “zombie apocalypse” theory of risk: if the whole economy collapses, you’ll have bigger things to worry about than your money.
And even if there were a default, the bills that are bought with this kind of fund are short term funds (30 days or so), so only small amounts of money would be defaulted on anyway.
So that’s technically a bigger risk, but how much something you’ll have to decide.
Is it worth it?
The purpose of an emergency fund is like self-insurance: if something goes wrong, you pay out money to help deal with it. And insurance isn’t supposed to make you money, it’s supposed to cost you money. You’re paying a price for a service.
Beyond the financial service, the emergency fund is providing you with peace of mind. Every single day.
So in some ways, I wouldn’t get to hung up on the rate of return for your emergency fund. A fund earning 0% is still providing a valuable service to yourself.
But, if you can earn a nice return on your emergency fund money, thus padding your emergency fund further, that’s not a bad thing.
If you live in a low-tax state, I probably wouldn’t bother with this. But many of us don’t, so there’s a real potential of margin here.
And I’m curious. So my plan is to throw a little bit of money in an account like the one I’ve been talking about above for maybe a year or so, and see how it does.
If, after the test period, it earns me an extra 0.5% when compared to my standard savings account, I’ll probably just call it a day and move my money back
But if the result is meaningfully different, I may start to move more money into one of these accounts. It would still provide the liquidity that I need in the event of an emergency, but with a higher return. I’d take that. These days, we need all the help we can get.
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