Many financial gurus recommend that you keep three to six months' worth of expenses set aside in a safe account as an emergency fund. But many investors don't want that money sitting in a savings account earning zero (or very close to zero) in interest. An intermediate bond fund would let your emergency cash be invested to earn some interest. You have to assess the additional risk of the bond fund, however.
Bond Fund Benefits
An intermediate-term bond fund owns bonds that mature in five to 10 years. Bonds in this range should pay significantly better yields than short-term bonds, certificates of deposit (CDs) or money market accounts. The intermediate term bonds will be less volatile than long-term bonds. Bond fund dividends can be automatically reinvested into more shares, allowing the account value to grow. With a bond fund, you can sell shares and have the money in your bank account in a few days.
Bond Fund Risks
The value of your bond fund investment can decline — and will do so if interest rates rise. The portfolio duration number published by the mutual fund company gives you an idea of how much the fund share price will change given a change in interest rates. For example a bond fund with a duration of six years would lose 6 percent of its value if interest rates increased by 1 percent. Conversely, if rates drop, the bond fund will increase in value. An intermediate bond fund account is not going to lose a large percentage of its value, but a drop of 10 percent or even a little more is not inconceivable.
Bond Fund Characteristics
If you are using a bond fund as your emergency fund, analyze different bond funds in terms of relative safety and stability. A fund that only holds government or investment-grade bonds has a higher safety factor than a fund that also owns non-investment-grade bonds. The portfolio page of a fund's website will provide a breakdown of the credit rating of bonds that a specific bond fund owns. A fund with an average maturity near the shorter end of the intermediate bond scale will be more stable than a fund with an average maturity closer to the 10-year limit.
Another option for handling your emergency fund is to split the money into two types of accounts. If you want to have six months of expenses as an emergency fund, you could put one-third of the money in a savings account at the bank where you can get to it quickly and the other two-thirds in the intermediate bond fund of your choice. With this approach, you have fewer worries about a drop in the bond fund value just when may you need the money the most.
Tim Plaehn has been writing financial, investment and trading articles and blogs since 2007. His work has appeared online at Seeking Alpha, Marketwatch.com and various other websites. Plaehn has a bachelor's degree in mathematics from the U.S. Air Force Academy.