Managing Your Float
A float, in the insurance industry, is the pool of money available for paying out claims. You pay premiums to an insurance company, they add it to their float and then pay claims from the funds in the float.
The float typically goes into liquid, low-risk investments so it earns a little income on the side.
When you self-insure, you too need your own float invested in liquid, low-risk investments to pay future claims.
Building Your Float
If you are starting from scratch, you have no float. Just like major insurance companies needed seed money to get started, so will you.
But first... do you carry any high-interest debt such as credit cards? If so, pay those off first. Self-insuring yourself can save you money, but paying off credit card debts will save you a lot more and a lot faster. If you pay 20% annually in interest, paying off that debt will save you 20% annually—guaranteed! Don’t even think about setting money aside for a float if you have high-interest loans.
If you do carry high-interest debts, this does not prohibit you from self-insuring relatively small risks. In a sense, you’ve been using debt as your float—but it’s a terrible option that raises your expenses rather than lowers them. If it’s the only thing available, use it—but get a plan in place to pay off those debts and build a real float.
Financial advisers often recommend stashing away six months of earnings in case of emergencies. This is a float! You’re insuring yourself against risks like losing your job: paying premiums into your float and—if you lose your job—you’ll pay claims out from the float.
Whether you’ve saved one month of earnings or six months (or more!)—this is a great starting point for your self-insurance float. Even if you only have $100 saved, it’s a small float and your self-insurance opportunities will be equally limited, but even that seed money can act as a float.
Investing Your Float
The number one purpose of your float is to pay claims—which, by definition, are unpredictable. So you should invest your float in something that is liquid (i.e. easy and fast to turn into cash) and low-risk (so it will be there when you need it).
And the best liquid, low-risk way to invest is a simple savings or money market account. Legitimate banks will be FDIC insured (at least for us Americans) so even if the bank goes bankrupt, your money will still be safe. And the money in your account is ready to transfer and use at the drop of a hat—which is as liquid as you can get.
The ideal account will have no monthly fees and pay a relatively high interest rate. Credit unions are great for no-fee accounts—and while their interest rates are generally better than most big banks, the best deals I’ve found are online banks. Without the network of brick-and-mortar buildings, they often pay much better interest rates.
I use Capital One. They are not paying me to say that—I really do use them and have done so for years. The accounts have no fees, no minimums and pay some of the best interest rates anywhere. But—full disclosure—if you follow the link, create an account, and fund it with at least $250—Capital One will add $20 to my account up to a maximum of $1,000. Joke is on them, though—I would have given the recommendation for free!
Over time, if things go well, your float will grow. Especially if you insure against risks that most likely will not materialize for many, many years such as retirement or health care expenses. For example, I started saving money in a Health Savings Account (HSA) when I was 30 years old. I had no known health problems. I never smoked, carried a healthy weight and—as far as I knew—could live to be 110. Probably not—statistically speaking—but theoretically...maybe? I was saving money for health costs that I did not expect to materialize for decades. A bank account earning interest will not provide satisfactory returns.
So the bulk of that particular account I moved to a brokerage that allows me to invest in the stock market. I keep a little in cash for small claims that could come unexpectedly and at any time, but the bulk of my HSA is invested in stocks with the expectation that it will help pay claims decades in the future. Stocks may fluctuate dramatically in value from year to year—definitely high-risk over short timespans—but I expect them to earn better results than a bank account over the long haul.
I also have a retirement account—another form of self-insurance. I plan to use it as my own, personal annuity. I do not expect to touch even one cent of that money until I reach retirement age decades in the future so setting a little aside in cash to handle unexpected emergencies is unnecessary. Instead, I keep it fully invested in stocks. As I get closer to retirement, I might set aside some for bonds—I’d like to avoid selling stocks if there is a stock market crash. By the time I retire and begin using the money, I’ll likely store some if it as cash that is readily accessible and low risk.
How to invest in the markets is beyond the scope of this website, but I’m a big fan of How a Second Grader Beats Wall Street. But in any case, if your float grows larger than your immediate needs require, you should definitely move the excess into a brokerage account where you can earn better rates than a bank account.