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 in the US?
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 the interest in a bank account. Money market funds typically provide a higher rate of interest than a savings account, while providing the same nearly-instantaneous access to your money when you need it. Sure, you could get a higher interest rate in long-term CD, but your money is locked in and you would pay a penalty to access it prior to maturity.
However to many, the idea of investing an emergency fund at all may seem fairly risky. My emergency fund is mostly invested in cash and term deposits 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 for your healthcare needs, or if your car needs to go in for a repair, if you need to take your dog to the vet, etc. 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: None 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 funds are best for my emergency money?
Let’s dive in to what I think would be the top 3 Vanguard mutual funds for your emergency money in the US.
VMFXX – Vanguard Federal Money Market Fund
This fund is considered one of the ‘safest’ of all Vanguard has to offer, and it’s tied firmly to US government securities. Over 99% of investments go into cash assets, meaning you can expect high liquidity – ideal for emergency funds where you may wish to remove your cash at short notice. It ranks a ‘one’ on Vanguard’s risk scale, meaning there’s little to worry about when it comes to potential loss.
VMFXX currently has a dividend yield of 2.13% (based on 7-day SEC yield), which is higher than the interest rate offered in most savings accounts currently. Note that unlike a savings account, VMFXX does not have an interest rate. Even though a standard savings account would be a comparison point for this fund, one should look at the dividend yield and not the interest rate on the VMFXX.
The nice thing is that this fund has never had a negative return quarter (never “broke the buck”), meaning your $1,000 invested in the fund will likely retain its value at any given point of time. Note however that the minimum investment amount with this fund is $3,000.
When it comes to returns, however, you may come up short. With a low-risk fund, you can generally expect lower returns. However this fund still provides somewhat better returns than a savings account. Sure, a CD may provide a higher interest rate, but then you’re stuck with your money being locked in for a specific period of time. A money market fund gives your a lower interest rate, but immediate access to your money.
VMFXX is a good starter fund for emergency money. Start here, perhaps, then look at a slightly riskier option. The expense ratio on the fund is a minimal 0.11%. There is no purchase or redemption fee.
This fund is similar to VMFXX, but with one important difference. VMRXX invests more than 25% of its assets in securities issued by companies in the financial services industry, which includes securities issued by certain government-sponsored enterprises. The fund therefore takes marginally more risk than VMFXX. This fund is still however classified as level 1 (out of 5) on Vanguard’s risk scale, so you do not have to lose sleep at night.
The fund historically has produced slightly higher return than VMFXX, however the low interest rate environment over the last several years meant that both funds have generated very similar returns. If interest rates continue rising and do not head back to 0%, on a forward looking basis, you may be able to get a tiny bit more return out of VMRXX compared to VMFXX.
VMRXX currently has a dividend yield of 2.16%. This is based on the standard 7-day SEC yield calculation. Note that unlike a savings account, VMRXX does not have an interest rate. Even though a standard savings account would be a comparison point for this fund, one should look at the dividend yield and not the interest rate on the VMRXX.
|7-day SEC yield||2.13%||2.16%|
As with VMFXX, this fund has never had a negative return quarter (never “broke the buck”), meaning your $1,000 invested in the fund will likely retain its value at any given point of time. Note again that the minimum investment amount with this fund is $3,000.
The fund’s expense ratio is 0.10%. There is no purchase or redemption fee.
VMSXX – Vanguard Municipal Money Market Fund
For those who have to hold their emergency fund in a taxable account, VMSXX might be a decent option as it has a tax-exempt status. On the flip side, this fund has generated marginally lower returns than the above two. As everyone’s tax situation is unique, it is difficult to provide a general recommendation about whether this would be the best option for you specifically. Nevertheless not having to pay any tax on the distributions from this fund makes it a compelling choice for those who may need it.
As the name suggests, the fund mainly holds municipal securities which have a tax-exempt status. The yield from the fund is dependent on the current interest rate environment, so you can look forward to slightly higher returns as the Fed raises interest rates.
VMSXX currently has a dividend yield of 1.54% (7-day SEC yield), which is lower than both VMFXX and VMRXX. As outlined above, VMSXX does not have an interest rate. The dividend yield is the correct metric to use here.
As with the above two funds, the fund has not experienced a negative quarter in the last decade. The minimum investment is $3,000 and the fund’s expense ratio is slightly higher at 0.15%. There is no purchase or redemption fee.
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 or liquidate these holdings as per your need. Additionally, as you can buy just 1 share, aside from the cost of buying that share, there is no minimum investment threshold.
Based on a review of the options that Vanguard offers, here is my opinion on which are the best 3 Vanguard ETFs in the US for investing and protecting your emergency fund.
VTIP – Vanguard Short-Term Inflation-Protected Securities ETF
This ETF tracks an index that measures the performance of inflation-protected US treasuries (TIPS) that have a remaining maturity of less than 5 years. As this fund has securities that have a relatively lower duration, its sensitivity to interest rate movements is low. On the flip side, you can still benefit from getting payouts that are linked to inflation, so you can preserve your capital when interest rates increase in an inflationary environment.
The ETF generally trades around the $50 mark and the expense ratio is a miniscule 0.04%. The inflation-protection means that the ETF will continue to deliver a reasonable performance in a high-inflation environment.
As the fund was launched in October 2012, Vanguard cannot report a 10-year performance figure just yet. However since we’re almost at the 10-year mark now, the “Since Inception” return of 1.72% is a good proxy for the 10-year return.
The fund did have some negative return quarters. It’s worst stretch was in 2014, when it was down 4.5% over 3 quarters sequentially (~1.5% in each quarter). So on a $1,000 investment, you would have been down $45. This of course makes it more volatile than money market funds discussed above, but on the flip side, it does deliver somewhat higher returns when held for a medium to long term.
It will be interesting to see how the inflation vs duration trade-off affects this fund in the coming few quarters. Nevertheless, despite some volatility it should still be a reasonable option for your emergency fund.
VGSH – Vanguard Short-Term Treasury ETF
Staying on the theme of short-duration high quality funds, VGSH invests primarily in US treasury bonds with a maturity between 1 to 3 years. This combination reduces the sensitivity of the underlying bonds, and hence the ETF, to any changes in interest rates. This bond has slightly lower volatility than VTIP, but also delivers slightly lower returns.
In the context of the rising interest rates, the ETF had a return of -3.3% in the past 1 year. This means that $1,000 invested in the ETF would have lost about $33 in value. Not great, but not a disaster by any means either!
There is no minimum investment required (aside from the cost of buying your first share) and the expense ratio is again a very low 0.04%.
BSV – Vanguard Short-Term Bond ETF
This fund is similar to VGSH in duration (1 to 5 years), however it takes slightly higher risk (going up the credit curve) by also investing in investment-grade corporate bonds and international dollar-denominated bonds. As of writing this piece, 68.2% of the fund is invested in US government securities and a further 19.3% is invested in A-rated or higher securities.
As you start to stray away from the highest quality and lowest duration securities, the interest rate sensitivity starts to increase. It’s therefore not surprising that the fund has delivered -4.61% return in the last 1 year. This means that on a $1,000 investment, you would be down around $46 so far.
You wouldn’t be out of place if you’re asking the question, why even bother investing here? The answer is that relative to VTIP, this fund has delivered better returns in some years. The recent weakness just drags down the overall longer-term numbers. To be honest, we’re likely splitting here when trying to compare BSV with VTIP. Even if you just owned VTIP, you would be perfectly fine.
There is no minimum investment threshold for BSV and the expense ratio is 0.04%.
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 options 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.