Where to Put Your Emergency Fund
So, you understand the importance of having an emergency fund, and you're wondering what is the best place to keep it. And that's what we're going to explore in this article.
If you're unsure why you need an emergency fund and how much emergency fund you should have, check out this article - Emergency Fund: An Important Part of Financial Planning.
Properties of Emergency Funds
First, let's review the properties that an emergency fund should have. It's crucial to store it in a place that offers low market risk, easy accessibility, and separation from your regular expenses to ensure that your emergency fund serves its intended purpose.
Low Market Risk
Having a low market risk for your emergency fund is essential because you want to ensure that your money will be available when you need it the most, especially during market or economic instability. The last thing you want is to invest your emergency fund in high-risk securities that can plummet in value, leaving you without the necessary funds when an unexpected expense arises.
Easy to Access
Your emergency fund must be easily accessible to let you take care of unexpected expenses quickly and efficiently. When an emergency arises, you don't want to waste time accessing your funds, have liquidity issues, or deal with complicated withdrawal procedures. By keeping your emergency fund in an easily accessible account, you can quickly access the funds you need to address the emergency without any unnecessary delays or hassles.
Separated From Your Regular Expenses
It's helpful to keep your emergency fund separate from your regular expenses to prevent the temptation to dip into it for non-emergency situations. When your emergency fund is mixed with your day-to-day expenses, you might be more likely to use it for shopping, vacations, or other non-essential expenses. By separating your emergency fund and putting it "out of sight, out of mind," you can avoid the temptation to use it for anything other than its intended purpose and ensure that your emergency fund remains intact and ready when you need it the most.
Other Determining Factors
The level of market risk and accessibility appropriate for your emergency fund will depend on several factors, including your job security, whether you have debt, monthly expenses, and the ability to find alternative employment in case of job loss. Other factors, such as ongoing financial commitments or health issues, can require your emergency fund to be highly accessible and shielded from risk.
For people with less stable or irregular employment, experts recommend keeping the emergency fund at a minimum market risk and highly accessible, as they may need to tap into it more frequently to cover their expenses during lean times.
Those with secure jobs, in-demand professions, no debt, and little expenses may have more flexibility to put their money to work and earn some income on at least a portion of their rainy day savings. It may be possible to take on a slightly higher level of market risk for potential returns as long as the funds remain easily accessible in case of an emergency.
The Best Places to Put Your Emergency Savings
1. High-Yield Bank Accounts
A high-yield savings account is an ideal place to keep your emergency fund due to its high accessibility and risk-free nature - they are FDIC-insured up to $250,000, so you can rest assured that your funds will be safe. Although the interest rates may be modest, your deposits will earn some income.
Some banks offer welcome bonuses for new customers who meet certain conditions, providing an upfront benefit. Compare different high-yield savings accounts to find the one that suits you best and ensure that your emergency fund is secure, accessible, and earning a decent return.
2. Online Savings Accounts
Conventional savings accounts are a secure option for your emergency fund, but the interest earned on them is generally low. However, online banks may offer slightly higher interest rates. If you don't mind not being able to access your funds by visiting a local branch, online banks can be a good option. Besides, online banks usually have lower fees due to fewer overhead costs.
3. Money Market Accounts
Money market accounts are another option for your emergency fund. These accounts can offer higher yields than regular savings accounts, making them an attractive option for those looking to maximize their returns. These accounts offer high liquidity and can be a good option for emergency savings. However, their fees can reduce your earnings, so keep an eye on them. Compare fees and features across different money market accounts before deciding where to park your emergency fund.
4. Certificates of Deposit (CDs)
This option is a bit controversial. While certificates of deposit (CDs) are a safe option that offers better returns, they are not the most accessible choice for emergency funds. With CDs, your funds are "tied up" for a specific amount of time, and accessing them earlier could result in penalties.
However, some people choose to "ladder" their CDs, or in other words, open multiple CDs with different maturity dates to ensure that some cash is always available. While this option may require a bit more planning, it can still provide a good balance between higher yields and accessibility.
The Worst Places to Put Your Emergency Savings
1. Checking Account
Combining your emergency savings with your everyday finances in the same account could be a recipe for trouble. You may be tempted to dip into your emergency fund with the promise that you'll replenish it when your next paycheck arrives, but there's a risk of breaking that promise.
Typically, checking accounts do not offer any interest earnings, and the purchasing power of your savings is vulnerable to inflation. The value of your savings will gradually decrease over time. It's best to separate your emergency fund from your regular expenses and keep it in an account with better returns to ensure that it's protected and maintains its value.
2. The Stock Market
Although the stock market is known for its potential for high returns in the long term, it is also highly volatile and unpredictable in the short term. In times of economic turmoil, the stock market can suffer significant losses - exactly when you may need your emergency fund the most.
3. Savings Bonds
Savings bonds can be an option for a portion of your emergency fund, but you need to consider the drawbacks. You cannot cash in a savings bond for a year after purchase, and if you do need to sell it within the first five years, you will forfeit three months of interest. Weigh the pros and cons of using savings bonds for emergency savings and consider other options that may be more accessible and offer better returns.