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Emergency Fund

Where to Put Your Emergency Fund

By Isaac Schweigert | October 20, 2015

Having an emergency fund means that you don’t need to rely on credit cards or other loans when an unexpected bill or unemployment happens.

Where should I put my emergency fund?

So you have saved up 3-6 months of living expenses as an emergency fund.

Your emergency fund should be:

  • easily accessible
  • liquid
  • unlikely to lose value

You don’t want to have all of your emergency fund locked into an investment that you can’t sell or in something that can lose value when you need it. If you were counting on 6 months of savings, you don’t want it to be only 5 months’ worth when you actually need it.

High Interest Savings Account (HISA)

These largely started when ING Direct (now Tangerine) opened its doors in Canada. HISAs offer interest rates that are above what regular savings accounts typically offer. These days nearly all banks, credit unions and other financial institutions offer HISAs, so you need to shop around to maximize your interest earnings.  If you are comfortable with keeping your money at a credit union you may not have heard of before, you can get rates as high as 1.85%. You will want to do a little bit of research into their reputations as some do not have a good reputation of strong customer service. Highinterestsavings.ca is a good place to start.

GICs

In order to get the best interest rate on a GIC you generally have to lock your money up. If you are going to put your emergency fund into a GIC make sure it is cashable, as even a good rate is meaningless if you can’t get your money out and have to rely on your credit cards in an emergency.

Going with a cashable GIC means lower interest rates. 1 year cashable GICs typically have lower interest rates than a HISA, but there are some exceptions like Tangerine and many of the credit unions. RateHub is a good place to compare rates. The best posted 5 year rate for a cashable GIC was 1.80%.  If you don’t have to cash it you get that rate, but if you do cash it, then your rate is much lower.

Market-Linked GICs

Most banks also offer “market-linked” GICs. Like regular GICs, market-linked GICs guarantee to return your money after a specified time frame, but if the market doesn’t perform well, the return on the GIC may be 0%. Some, but not all, have a guaranteed minimum return. This is usually lower than the return on the basic GICs described in the above section.

To calculate the return, the bank takes the difference between the value of a stock market index (or basket of stocks) on the date you purchased the GIC and the value of the stock market index (or basket of stocks) on the GIC’s maturity date. Many of these GICs also have a maximum return, meaning that if the stock market index does really well, say it was up 15%, the return on your GIC may be limited to 6%. I won’t go into why they are structured this way, but it involves the bank’s hedging and derivatives costs.

Most market-linked GICs are not cashable, so they probably are not suitable for your whole emergency fund.

Money Market Mutual Fund

Money market mutual funds invest in short term debt securities such as treasury bills, bankers’ acceptances, commercial paper, and certificates of deposit. Since these funds are meant to be suitable as a cash replacement, they typically hold debt that matures in less than 3 months. Since interest rates on short term debt are very low right now, some fund managers buy longer term debt in an attempt to increase yields.

Since the fund manager has to be paid, money market funds have an expense ratio, just like any other type of mutual fund.

In order to maximize your return, you need to keep the MER low. According to Morningstar, the average MER on Canadian money market mutual funds is 0.60%. If the yield on the investments in the fund is 0.80%, then the net return to you is going to be 0.20%.

Money Market ETFs

If you like the idea of a money market mutual fund, but don’t like the high MERs, there are a few money market ETFs in Canada to choose from. The MERs are lower, but the distribution yields are still very low.

The current distribution yield on the iShares Premium Money Market ETF (CMR) is only 0.24%. Your other option is the Purpose High Interest Savings ETF (PSA). PSA’s MER is a little lower which helps make the yield a little higher at 0.98%.

Short-term Bond ETFs

Another alternative to money market mutual funds is short-term bond ETFs. Most of these hold primarily Canadian and/or US government debt, so the risk of default is very low. However, if interest rates rise quickly (unlikely but possible), the value of the bonds held by the ETF could decline in value and you would lose money.

The distribution yields on these ETFs are attractive at around 2.50%, however the yield on their investments are between 1.0% and 1.3%. That means that part of every distribution you receive is actually a return of your capital. This is advantageous from a tax perspective as about half of the distribution won’t be taxable.  All of the major ETF providers in Canada such as BMO, iShares and Vanguard offer short-term bond ETFs.

Those are your options. What do we recommend?

Your safest option is to use a High Interest Savings Account. The name is a bit of an oxymoron these days, but HISAs meet all 3 criteria for an emergency fund. Remember, your emergency fund is not an investment. It is insurance against having to take on high interest debt, and insurance always costs money.

If you really hate the idea of only earning 0.80% to 1.80% on your emergency fund, you could consider a ladder. For example, say you have a $12,000 emergency fund that is meant to last for 6 months (i.e. $2,000 per month). The first 4 months, or $8,000, could be kept in a HISA. The other 2 months, or $4,000, could be kept in a short-term bond ETF or a GIC.

If you have a balance on a revolving line of credit (like a home equity line of credit) you could pay that down with your emergency fund and then withdraw from it again when you really need it. Just remember to keep that amount available on your line of credit so it is there when you need it.


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Isaac Schweigert

Isaac Schweigert

Isaac is a CFA charterholder and is Portfolio Manager and Chief Compliance Officer at ModernAdvisor. He has over 11 years of investment industry experience, including asset allocation, portfolio management, due diligence, compliance and reporting.