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You need to have an emergency fund. If you do not have one, this should be one of your top financial priorities. In this article, we’ll explore the basics of the emergency fund, and how you can use Series I bonds as part of your emergency fund strategy.
The Basics of an Emergency Fund
Conventional wisdom says that 3-6 months of living expenses in an emergency fund can help save you from unexpected financial shocks. To me, 3 months seems insufficient in an uncertain job market. Therefore, shoot for 6 months (or more).
Emergency funds are meant to cover true emergencies. An emergency fund shouldn’t be used to cover expenses that are reasonably anticipated. For example, if an air conditioner is 15 years old, it shouldn’t be an “emergency” when it breaks and needs to be replaced.
Research shows that most Americans end up using their emergency fund for household repairs or car expenses; planning for these expenses can ensure your emergency fund remains available when a true emergency arises (like a loss of income or unexpected medical expenses).
Conventional Wisdom on Emergency Funds
Keep your emergency fund in cash in a savings account. That’s the typical advice. However, in a traditional savings account, the buying power of an emergency fund declines over time. Except in unusual circumstances, the interest rates of savings accounts are typically less than the rate of inflation.
However, liquidity is important so that you have access to your emergency fund when you need it. So, how can you avoid having the buying power of your emergency fund shrink?
As you’re working on building up your savings, check out our guide on where to save first.
The Alternative to a Traditional Savings Account
The Treasury offers a little known product called a Series I savings bond. What is a Series I savings bond? Series I bonds are government-backed bonds from Uncle Sam that is designed to track inflation. These bonds are meant to protect your savings from inflation.
Mechanics of the Series I Savings Bond:
- The interest rate is a fixed rate plus an inflation rate that is adjusted twice per year.
- Interest earned on Series I bonds are exempt from state and local taxes.
- You must hold the bond for at least 1 year.
- 3 months of interest are forfeited if you hold the bond for less than 5 years.
Emergency Fund Savings Account Alternative: Series I Bonds
While having some cash on hand is important for emergencies, Series I savings bonds allow the purchasing power of your emergency fund to remain constant. There are a couple of downsides to Series I bonds. You must hold each bond for at least 1 year. Redeeming the bond before year 5 will cause you to forfeit some interest/
However, one way to leverage this tool is to build a ladder of Series I savings bonds. Investing a portion of the emergency fund over time will create a number of Series I bonds each of which will hit that 1-year mark at different times. This way, if redemptions are necessary, you will have the flexibility to redeem the bonds. As an example:
January 2021: Bought $2,000 Series I Savings Bond
January 2022: Bought $2,000 Series I Savings Bond
June 2022: Need $2,000 of emergency fund; can tap 2020 bond and forfeit 3 months of interest.
One other benefit of Series I bonds is that it puts cash in a slightly more illiquid vehicle. Personally, this helps ensure that I don’t tap emergency savings for events that are not true emergencies. I am a firm believer that putting your cash someplace that is harder to access can help you build real wealth.
Just remember, having access to some cash for an emergency fund is critical, but if you have a sizable emergency fund, Series I savings bonds can be a valuable tool to maintain the buying power of your emergency fund.
To learn more about Series I savings bonds and open a TreasuryDirect account, visit https://www.treasurydirect.gov/indiv/research/indepth/ibonds/res_ibonds.htm.