If there's one thing that the COVID-19 pandemic has taught us, it's the importance of being prepared. It's something that many people, unfortunately, were forced to deal with quickly and unexpectedly.
It brought to the surface the notion that many people had precious little money set aside to help cover emergencies or other unforeseen events. Many families have struggled to pay the rent or even put food on the table and it's something a lot of people are still dealing with today.
The pandemic has emphasized the need for everyone to have an emergency fund set up for themselves. Many financial advisors suggest having something like 3-6 months of living expenses set aside to cover the unexpected. Outside of a major event, such as a pandemic, examples that an emergency fund might be used for include a car accident, job loss or unexpected medical expense. The idea of an emergency fund is to make sure you're not one event away from a financial catastrophe.
If you're looking to set up an emergency fund for the first or want to make sure your existing fund is in the right place, the ETF marketplace is a great place to look.
Rules For Building An Emergency Fund
But before you start saving, there are a few guidelines you should follow.
- This isn't the place to be taking risk. Savers should be using money market funds, Treasury bills or other ultra short-term fixed income products for their emergency fund. CDs are only OK for this purpose. The idea of locking up your money at a bank, even for short-term periods, isn't ideal when you could need the money at a moments notice.
- Don't worry about returns. This is an ultra low interest rate environment we're in, which means yields on the funds you'd consider for an emergency fund could be next to nothing. In a different time, you might be able to earn 3% on a money market fund, but that time isn't today. The most important thing is that the money is there when you need it.
- Make sure it's liquid and accessible. You can use a bank money market or money market mutual fund for an emergency fund, but make sure you have checkwriting and/or a direct link to your bank account set up so you have access to money quickly. The same thing applies to the use of an ETF. Make sure you can take the money out of your brokerage account and send it to your bank immediately if needed.
Again, I think money market accounts are great for building emergency funds. Some money markets at places, such as Vanguard, however, might require a few thousand dollars to start. Some investment companies require much lower minimums if you're starting with less and banks usually require only a minimal, so seek those options out if necessary.
5 ETFs For Building An Emergency Fund
But I'm an ETF guy, so I'll be giving you a handful of options if you want to build your emergency fund through these products instead. There are a lot of great low-risk, low-cost choices among ETFs. Here are a few of my favorites.
SPDR Bloomberg Barclays 1-3 Month T-Bill ETF (BIL)
As far as ETFs go, this is about as conservative as you'll find. The 3 month and less maturity requirement means there's almost no interest rate risk involved. The fact that it's invested in Treasuries means there's almost no credit risk involved. As far as safety goes, you may not find a less volatile ETF around.
Of course, T-bills are yielding pretty much nothing right now, but as I mentioned before, principal protection is the goal of an emergency fund. Given its overall profile, this is very similar to a traditional money market fund.
Goldman Sachs Access Treasury 0-1 Year ETF (GBIL)
The next step up would be investing in a T-bill ETF that allows maturities up to a full year. GBIL does that, but still has the majority of assets in Treasuries with maturities of 6 months and less. It has the same ultra low risk profile as BIL, but adds just a touch of higher risk and yield potential.
WisdomTree Floating Rate Treasury ETF (USFR)
Floating rate Treasuries have a bit of a different structure than BIL and GBIL, but have a yield/risk profile that's substantially the same. USFR holds Treasuries with longer maturities (up to about 2 years out looking at the current portfolio), but because the interest rates reset on a regular basis, they end up behaving more like Treasury bills.
USFR has just over $1 billion in assets, making it smaller than GBIL and significantly smaller than BIL. That could mean minimally higher trading costs, but USFR is still liquid and cheap.
JPMorgan Ultra Short Income ETF (JPST)
This is the first ETF on the list that focuses on ultra short-term investment grade corporate bonds instead of Treasuries. That means you're introducing credit risk into the equation, which tends to up the volatility a bit.
Most of the portfolio is in the AA- to BBB-rated range, still safe enough to pose little default risk, but enough to make the portfolio modestly riskier. The current yield of around 0.3% means you get a little bit of income for your trouble, but JPST is simply an option for those wishing to increase their risk/return profile a bit without taking too much risk.
It's worth noting that even ultra short-term corporate bond funds ran into trouble during the COVID bear market last year. JPST dropped more than 3% over the course of a few weeks back in March when investors abandoned anything with risk and share prices started disconnecting noticeably from their underlying NAVs, something that is very unusual with ETFs. In the vast majority of cases, risk here is low, but last year shows that things can still go sideways in the wrong conditions.
PIMCO Enhanced Short Maturity Active ETF (MINT)
MINT actually combines Treasuries and investment-grade corporates into one portfolio (although it leans heavily towards corporate bonds currently). It's also actively managed, so it tries to pick and choose only the best opportunities within the fixed income landscape.
From a risk perspective, it has the same story as JPST a year ago. Its share price dropped about 4% in short order, but was able to recover its losses by June once the market stabilized. Among short-term safer bond ETFs, MINT has been one of my favorites.