Do you have an emergency fund set up? Or are you simply looking for where to park your cash? If you are looking for ways to squeeze some extra returns out of your emergency fund, you may want to look at options other than a simple chequing account. Selectively and carefully, there are some options to invest your funds in to the financial markets. But which one to choose? What are the best Vanguard funds for your emergency fund?
If you’ve been following Project Financially Free for some time, you’ll know that I’ve reviewed the best Vanguard funds in the UK. I have also reviewed Vanguard a handful of times up against some of the biggest investment apps and companies around.
In this guide, I’ll be taking a look at whether or not Vanguard offers funds where you can feasibly keep your emergency money safe, and which are likely to prove most beneficial.
Why should I invest my emergency fund?
The main goal of investing an emergency fund in the markets is to generate a higher return on the cash than one would receive in a bank account. However to many, the idea of investing an emergency fund at all may seem fairly risky. After all, it’s technically betting your money on the chance the markets will increase your total or eat away at your savings! My emergency fund is mostly invested in cash along with some physical gold and silver.
Prior to investing, always consider your circumstances. If your particular line of work doesn’t provide you with stable income, or you’re just getting started building up your emergency fund, it’s probably not worth taking the investment route just yet. What’s more, you need to be shrewd about what you’re going to use your emergency fund on. Will lives depend on this money? If so, it’s probably not a good idea to put it all at the mercy of your markets.
What’s more, if you’re in the process of paying off debt at a high rate of interest, you should focus on clearing that before gambling your emergency money on funds and portfolios!
Before looking into any fund with Vanguard, it’s important to remember the precise purpose of an emergency fund. This isn’t money you’re going to want to play around with – this is a fund that you’re going to need access to at short notice in the event of an emergency – as it says in the name!
Emergency funds are ideal for falling back on if your car needs to go in for a repair, if you need to take your dog to the vet, or if you need to take time off work for illness (and don’t have any insurance). Regardless, before you even start looking for funds, remember you’re not in it to make money right away!
If anything, making money on an emergency fund should be a perk.
However, if you are willing to accept a modicum of risk when investing your emergency fund – and you already have a savings pot established – it might be a good idea to look at diversification.
Asset Allocation Questionnaire
I have earlier presented a simple asset allocation framework and it is appropriate to apply that framework here to determine how best to allocate an emergency fund. It’s a good exercise and will help frame our thinking:
- Time Horizon: Indeterminate. By nature, one cannot predict when an emergency occurs, so while it could take many years before you need this cash, when an emergency happens, you need the cash immediately.
- Risk Tolerance: Nil to Low. We want all our money to be there when we need it. Our fund can’t be down 10% or 20% when we need it. We can live with a maximum downside of 5%.
- Return requirement: At a minimum, keep pace with inflation so the fund does not lose its spending power.
This analysis shows that we want our money to be available at short notice (in the order of a few days) and it should all be there! At the same time, this pot of money is not required to attain the maximum returns possible.
This means that at the most basic level, an emergency fund covering up to 3 months of expenses should almost always be invested in a cash or cash-like product such as money-market funds. Once we have that covered, we could potentially examine other avenues such as investing in alternative assets like short to medium-term treasury funds or in precious metals.
Providing you’re careful about the funds you choose, you can avoid losing serious money. Crucially, it would be well advised to steer clear of funds holding any equity, long-term bonds, or non-investment grade debt – as there’s never any guarantee that the portfolio will hold its value at any given point in time.
Which Vanguard index funds are best for my emergency money?
Before choosing a Vanguard index mutual fund for your emergency savings, remember that the right choice for you may not be that which suits others who give you advice online! And remember, an index fund is simply a mutual fund which tracks an index passively – meaning that it will have much lower fees than a traditional mutual fund.
Let’s dive in to what I think would be the top 3 Vanguard index funds for your emergency money in the UK.
Sterling Short-Term Money Market Fund
This index mutual fund mainly invests in products such short-term money market instruments, bank deposits (time deposits and certificates of deposit), UK government short-term treasuries, UK commercial paper. What this means for you is that this fund would be functionally equivalent to cash. The OCF on this fund 0.12%.
As expected, the fund’s historical returns are minimal at 0.85% over the last 3 years. However crucially, the most that the fund has been down in any given month is 0.02%. This means your £1,000 invested in the fund would not have been down more than 20p at any given point.
Vanguard classifies this fund as Risk Level 1 of 7, meaning it is their lowest risk product. You can own this fund and sleep peacefully at night knowing that your funds will be safe.
Global Short-Term Bond Index Fund
This index fund takes on more risk than the Sterling short-term money market fund and hence the fund is bit more volatile. The fund invests in bonds issued by global governments, government-related agencies, corporate and securitised bonds, with a maturity between 1 and 5 years. In order to reduce the impact of foreign exchange movements, the fund is hedged in GBP. Consequently, the OCF for the fund is a bit higher than the above fund at 0.15%.
Over the last 3 years, this fund had a cumulative return of -1.08%, but a five-year return of 1.32%. The returns for the last 3-years look unappealing, however its important to remember that in the current inflationary environment, quickly rising interest rates pose a challenge for any bond or fixed-income fund. Going forward as the pace of interest rate hikes hopefully moderates a little, these funds should resume delivering positive returns.
The most that the fund has been down over the course of a year (due to multiple consecutive monthly declines) is 4.18%, which means that your £1,000 would have been down at most £42 in the last year. It’s not desirable, but not the end of the world either.
Vanguard classifies this fund as Risk Level 2 of 7.
U.K. Short-Term Investment Grade Bond Index Fund
This index fund invests in investment-grade bonds, excluding government bonds, denominated in UK pounds sterling, with maturities between 1 and 5 years. As the fund invests in non-government bonds and in securities with maturity of up to 5 years, there will naturally be somewhat more risk and volatility than the Sterling short-term money market fund. The OCF is 0.12%
Over the last 3 years, this fund had a cumulative return of -1.85%, but a five-year return of 1.5%. The most that the fund has been down over the course of a year (due to multiple consecutive monthly declines) is 5.04%, which means that your £1,000 would have been down at most £50 in the last year. Again, nothing to lose sleep over.
Vanguard classifies this fund as Risk Level 3 of 7.
Which Vanguard ETFs are best for my emergency money?
Much like index funds, ETFs track an underlying index. However they bring the added flexibility of being traded continuously on an exchange, which means you can easily add to or liquidate these holdings as per your need.
It is however important to note here that none of the ETFs offered by Vanguard in the UK are classified as either Risk level 1 or 2 (of 7). The starting point for these ETFs is at level 3. This is crucially important to note.
Additionally, some of the challenges for these ETFs include:
- No domestic focus: None of the ETFs have a domestic focus, which means that you are automatically taking on some additional risk by going international.
- No currency hedging: The funds are not hedged to reduce or eliminate FX movements, which means that you are at the mercy of the global FX markets and macro challenges.
- Large drawdowns: Even the lowest risk ETFs (such as the USD Treasury Bond UCITS ETF or EUR Eurozone Government Bond UCITS ETF) have drawdowns in the range of 10%.
Neither of the above are characteristics that suit an emergency fund. If your 3 month (or 91 day) emergency fund is down by 10% when you need it, you have lost 9.1 days, or almost 1.5 weeks, worth of cushion. Not very appealing!
Given the lack of a suitable choice in the Vanguard ETF stable in the low-risk category, I am going to say that there is no suitable Vanguard ETF in the UK for an emergency fund. Your best bet is to stick with Vanguard’s index funds for your emergency funds.
Should I invest my emergency fund with Vanguard?
Vanguard’s reputation in money management is well-regarded – they are amongst the longest-standing investment experts still operating today. That said, this doesn’t confirm whether or not keeping your emergency fund in a risky portfolio is the best option to take.
My advice would be to try investing a portion of your emergency fund a little at a time. This is especially worthwhile if you’re completely new to the markets. Vanguard’s funds and ETFs are diversified enough to protect what little money you invest to a degree, but you have to consider if it’s worth going through the hassle to generate slightly higher return compared to a simple bank savings account.
The focus with saving an emergency fund shouldn’t be to make money, rather to safeguard it – but if the opportunity arises for you to generate income on the back of your savings, you should never pass on it.
Investing can be highly lucrative, but it’s not worth doing so – with Vanguard or any other provider – until you can be sure that you have the financial safety net to protect your interests in case things head south. The last thing you’ll want to do is place all of your money in one fund, only for it to experience a dip and result in you losing that safety net.
Be sure to research and review multiple banks and savings pots before leaping into the financial markets – while it may appear exciting, there’s no need to gamble your emergency pot away unless you can be sure the dividends or returns far outweigh the risks.