Still to this day, I ask myself, where should I have my emergency fund? Every time I see a savings account with a high interest rate or when the stock market goes on a nice bull run, I find myself reassessing where I’ve stored my emergency savings.
Can I get a better return? Am I using the best strategy? There are a few different options that I run through at least once a year. Here is what I consider:
According to the US Bureau of Labor Statistics (BLS), the current inflation rate as of March 2019 is 1.9% annually. If your emergency fund is earning less than 1.9%, then you are losing money to inflation.
Inflation can be defined as a general increase in prices and a decrease in the purchasing value of money. You can find this number by simply Googling “Current Inflation Rate”
Example: Say a can of soda costs you a dollar in 2000. That same can of soda will cost you $1.50 in 2019. (The BLS has an inflation calculator that is fun to play with if you are curious. Or if you’re just a nerd like me.)
Bank Savings Accounts
Savings accounts tend to be the go to for emergency funds. I currently have mine in a savings account. It’s the safe option, where you have a good chance to earn more than you are losing with inflation.
If however, you are not, then you need to shop around. Maybe consider online banks; many tend to pay a higher interest rate.
Also, if the bank requires you to jump through hoops in order to get that super high rate, like requiring direct deposits and/or a set number of debit card withdrawals, this is not the account for you. At least for your emergency fund.
Emergency funds should not be touched unless there is an emergency – hence the name. Requiring you to constantly move money around and actually make transactions with the account makes it way too easy to use the money for non-emergencies.
Certificates of Deposit
Certificates of Deposit or CDs are another option, but a trickier, more time-consuming option. I would really only consider this option if an emergency fund was very large for some reason. Like if you are taking a nice long sabbatical from working and therefore have no income.
With CDs, you would want to build a “CD Ladder.” As an example, you could split your funds into four, then buy a six-month CD, a 12-month CD, an 18-month CD, and leave the last portion in cash.
As your shortest CD comes due, it returns to cash plus the interest the CD earned. Then you take the cash and buy another 18-month CD. In the end, you are just buying 18 month CDs every time a CD matures. The goal here is to capture whatever interest rate the 18-month CD is paying at the time of purchase, which is typically higher than a savings account (typically, not always).
You’ll need to watch out for two things with this strategy. First and most importantly, you will need to be certain that the amount you leave in cash is enough to make you feel like you can handle most emergencies. If you have all of your cash tied up in CDs, then it makes the cash harder to access when something does actually come up.
Secondly, keep an eye out for possible surrender charges. With many CDs, if you need access to the money before the CD’s time is up, you may need to pay a surrender charge. That charge could completely wipe out the interest you were trying to earn and possibly take some of your principal as well.
This option is one that I tend to overlook, but I also tend to think that the world will stay pretty stable. With physical cash, you don’t earn anything in interest so you are constantly losing buying power (see inflation example above).
You will also need to keep the cash safe, without forgetting where you put it. Physical cash is easy to steal. And not just for burglars, but for anyone who enters your home – hopefully no one you know would actually steal from you, but you never know what someone may be going through.
With that said, you are the one keeping your cash safe, not an institution. If there’s a run on banks, if the apocalypse comes, or if the Walking Dead becomes reality, the chances of you getting any money from a bank drops off of a cliff. Having a little cash stashed away somewhere might not be the worst idea in the world. Totally up to you.
I know a few people who use their Roth IRA (Individual Retirement Account) as a savings account. This it typically frowned upon by the financial world as IRAs are supposed to be used for retirement savings, not emergency funds or general savings.
The benefit here is that you can invest the money and it grows tax-free. If you don’t end up using the money then you’re setting yourself up for a nice retirement. But if you do need to use the money, then you just entered a world of tax rules and complications, and possible penalties.
I personally don’t consider this option when looking for a place to stash my emergency fund. I don’t think it is worth the possible headache.
I hesitate to bring this one up because I know that this option can become quite dangerous if you don’t stay very on top of things. But the accrued interest is lower than a credit card.
If you like the idea of investing all of your savings (something that is not recommended by almost everyone), then you could look into margin accounts at a broker/dealer.
Accounts with margin allows you to take “loans” out on your investments. You’ll pay the broker/dealer interest on the amount you take out and if your investments drop in value you may need to pay back the loan immediately or risk getting sold out of your investments.
In short, you can lose your ass really quickly. There are people who make this option work for them. They typically have a good amount of money already. I would highly recommend that you do not use this for your emergency fund unless you are already loaded and very investment savvy.
If this is something you are interested in, call your broker’s 800 line and talk to them about it. They will be able to see your exact situation and will hopefully be able to talk you out of it if they think it is too risky for you.
Safety and Liquidity
When it comes to where you put your emergency fund, you want to ensure you have both safety and liquidity. This is why I rely on typical, boring savings accounts. The money is there when I need it and it’s making at least enough interest to cover inflation. And it doesn’t come with any added stress such as angering the IRS.
There is one more option that is sadly used quite frequently by the everyday American, and that is credit cards. Credit cards should be an absolute last resort (aside from the margin account).
Using a credit card for a purchase that you cannot pay off in the very near future is like knocking on the door to financial unhappiness. That’s how you get yourself into debt. Just don’t do it. Cut back on expenses now, build up your savings, and then use your emergency fund only when necessary.