It’s always a good idea to keep some money set aside in a liquid form. It’s a double-edged sword because the more liquid your money is, the less it’s earning. If you never have an emergency fund saved, then you can miss out on the chance for substantial earnings. So, what to do?
Why Stocks and Bonds Are Poor Choices for Emergency Funds
When considering where to put your emergency funds, make sure you’ll be able to access the money quickly, easily, and without withdrawal penalty when you need it. Most financial professionals don’t recommend investing your emergency fund in the stock market because stocks are volatile. You don’t want to have to sell an investment at a loss to access your emergency fund.
Bonds are generally a poor choice for similar reasons, though they can be less volatile than stocks. Dave Ramsey, the longtime host of a financial advice radio show, author of several personal finance books, and designer of programs to help individuals get out of debt, recommends that individuals keep three to six months’ worth of expenses in an emergency fund in a checking or money market account that has debit card or check-writing privileges so you can quickly and easily pay for an emergency expense.
Other Possibilities
The problem is, money in a traditional checking account at a brick-and-mortar bank will earn little or no interest in today’s low interest rate environment. When you’re not earning interest, you’re actually losing money to inflation every year. Ideally, your emergency fund would at least be earning 2% to 3% per year to keep pace with inflation, but when even savings accounts are barely paying any interest, this is a difficult task. So how can you get as far away from 0% and as close to 2% or 3% as possible while still keeping your emergency fund highly liquid and not putting it at risk?
Favoring money market accountsover checking accounts may help however money market accounts are safe. Many are FDIC-insured (Federal Deposit Insurance Corporation), and the ones that aren’t generally have pristine records and tend to pay more interest than checking or conventional savings accounts. Some leading online banks, such as Synchrony, offer money market accounts that come with debit card and/or check-writing privileges, which gives you instant access to your funds.
If you can trust yourself not to spend your emergency fund on things it wasn’t intended for, keeping it in a high-yield savings account at a bank where you also have a checking account should allow you to instantly transfer funds from savings to checking, so you can access money via debit card, ATM or check in an emergency. A high-yield online savings account is another option for your emergency fund. As with a physical financial institution, money in an online savings account is FDIC-insured – and online accounts typically pay more interest than brick-and-mortar accounts, since online banks don’t have the overhead expenses that traditional banks do. Just make sure you know how to access your money in an emergency, since you won’t be able to walk up to a bank teller and make a large withdrawal. Ally Bank, for example, says you can access the money through an online funds transfer, outgoing wire transfer, telephone transfer or check request. Other methods of accessing emergency savings in an online account may take several days, and you may not be able to wait that long.
Of course, the more you deposit, the more you’ll earn. But make sure the account you’re considering does not require you to have a higher balance than you plan to maintain to get the interest rate you’re looking for. If you only have $1,000 to …