Strategies For Investing Your Six-Month Emergency Fund Wisely

It's important to have an emergency fund to prepare for unforeseen financial difficulties such as job loss, medical bills, or home repairs. Experts recommend setting aside three to six months' worth of living expenses in a separate, easily accessible account. While there are several options for where to keep your emergency fund, high-yield savings accounts, money market accounts, and certificates of deposit are generally considered the best places to park your funds, offering a balance of liquidity, protection, and interest rates.

High-yield savings accounts

When choosing a high-yield savings account, look for one with a strong interest rate, good perks, and national accessibility. The best options also tend to have no monthly maintenance fees and low minimum opening deposits. Here are some of the top high-yield savings accounts to consider:

• CIT Bank Platinum Savings: This account offers a competitive interest rate of 4.70% APY with a $5,000 minimum balance.
• SoFi Checking and Savings: This account offers a variable interest rate of up to 4.30% APY with no minimum balance requirement.
• BrioDirect High-Yield Savings Account: This account offers a competitive rate of 5.15% APY and doesn't charge any monthly maintenance fees, but it requires a $5,000 minimum opening deposit.
• American Express High Yield Savings Account: This account offers a yield of 4.10% APY with no minimum balance requirement.
• Capital One 360 Performance Savings: This account has no minimum deposit or balance requirements and offers an interest rate of 4.10% APY.

Money market accounts

Another benefit of money market accounts is that they offer competitive interest rates, which can help your emergency fund grow over time. As of October 2024, some of the top money market accounts include:

• Vio Bank: 5.20% APY, $100 minimum deposit
• Quontic Bank: 5.00% APY, $100 minimum deposit
• CFG Community Bank: 5.00% APY, $1,000 minimum deposit
• UFB Direct: 4.57% APY, no minimum deposit
• Ally Bank: 4.00% APY, no minimum deposit

However, it's important to note that money market accounts may have a higher minimum balance requirement compared to traditional savings accounts. Additionally, there may be limitations on the number of withdrawals you can make per month.

Overall, money market accounts offer a good balance of liquidity, protection, and interest rates, making them a suitable option for your emergency fund.

Certificates of deposit

CDs are a safer and more conservative investment than stocks and bonds, but they offer a lower opportunity for growth. They are insured by the Federal Deposit Insurance Corp. (FDIC) or the National Credit Union Administration (NCUA), which means that up to $250,000 of your funds are protected in the rare event that the institution fails.

CDs come in a variety of terms, from 3-, 6-, or 12-months to 4-, 5-, and even 10-year terms. The longer the term, the higher the interest rate is likely to be. When opening a CD, you'll need to consider the interest rate, term, principal, and financial institution.

One of the downsides of CDs is that your money is locked into the investment. However, this can be beneficial for savers who worry about withdrawing from their savings. The fixed term of a CD and the penalty for early withdrawal act as a deterrent to spending.

CDs are a good option if you have cash that you don't need now but will want within a few years. They are also a good option if you want to invest some of your savings conservatively, as they are less risky than stocks and bonds.

A CD ladder is a strategy that enables you to access the higher rates offered by 5-year CD terms while keeping your money relatively liquid. It involves dividing your funds into five CDs of varying term lengths (for example, one CD each of 3 months, 6 months, 12 months, 18 months, and 24 months). When the first CD matures, you roll it over into a new 5-year CD. A year later, when your initial 6-month CD matures, you roll it over into another 5-year CD, and so on. This way, you always have a portion of your emergency fund accessible.

Roth IRA

A Roth IRA is a flexible retirement savings account that can be used as an emergency fund. It allows you to withdraw your contributions at any time without penalties or taxes, making it a good backup option for emergency savings. However, it's important to note that you should only withdraw from your Roth IRA as a last resort and there are specific rules regarding the type of funds you can withdraw.

• Tax Benefits: The main advantage of a Roth IRA is its tax benefits. Contributions are made with after-tax dollars, meaning you've already paid income tax on them. As a result, you can withdraw your contributions at any time without incurring additional taxes or penalties. This provides flexibility in case of an emergency.*
• Investment Earnings: While you can withdraw contributions at any time, it's important to distinguish between contributions and investment earnings. Any earnings on your contributions must remain in the account for at least five years and ideally until you're 59½ years old to avoid a 10% early withdrawal penalty and taxes. So, while your contributions are easily accessible, the earnings are meant for long-term retirement savings.*
• Contribution Limits: There are annual contribution limits to Roth IRAs. For 2023, the limit is $6,500, and it increases to $7,000 for 2024. If you're 50 or older, you can make an additional "catch-up" contribution of $1,000. These limits should be considered when using a Roth IRA as an emergency fund, as you don't want to hinder your retirement savings.*
• Replenishing Withdrawals: If you do need to withdraw from your Roth IRA for an emergency, it's important to replenish those funds as soon as possible. You have until the tax-filing deadline of the following year (usually April 15) to redeposit the amount you withdrew. This allows you to retain your Roth contribution for that year and maximize the tax-free growth of your retirement savings.*
• Separating Emergency Funds: When using a Roth IRA as an emergency fund, it's crucial to keep your emergency funds separate from your retirement savings within the account. This means allocating your contributions specifically for emergency purposes and avoiding investing them in stocks, bonds, or mutual funds. This ensures that your emergency funds remain liquid and easily accessible.*
• Consider Other Options First: While a Roth IRA can be a useful backup, it's generally recommended to build an emergency fund in a regular savings account first. This ensures that your emergency savings are easily accessible and don't impact your long-term retirement goals. The recommended emergency fund covers at least three to six months' worth of essential living expenses.*

In summary, a Roth IRA can provide a safety net for emergencies while also offering tax advantages for retirement savings. However, it's important to understand the rules and limitations to make the most of this account and effectively balance your short-term and long-term financial goals.

Savings accounts

When choosing a savings account, look for one with a high interest rate. Some savings accounts, such as high-yield savings accounts, tend to pay higher rates than traditional savings accounts. For example, you can earn 3% to 4% from many high-yield savings accounts compared to an average APY of about 0.3% from traditional savings accounts.

You can also consider a money market account, which is a sort of mix between a checking account and a savings account. They are considered low risk and can provide APYs of about 3% to 4%. Most money market accounts are insured by the Federal Deposit Insurance Corporation (FDIC) or National Credit Union Association (NCUA), which means your money will be protected up to $250,000 per account. Some banks offer money market accounts that come with debit card and/or check-writing privileges, which gives you instant access to your funds.

Another option is a certificate of deposit (CD), which can provide more interest than keeping your money in a checking account. Like a money market account and high-yield savings account, a CD offers FDIC protection for up to $250,000 per account. However, keep in mind that many CDs penalize you for taking money out before they mature, so they may not be the best option for your emergency fund if you think you'll need to access the money quickly.

When deciding how much to save in your emergency fund, aim for three to six months' worth of living expenses. If that seems like too much, start with a smaller amount that you feel comfortable with. For example, having access to $500 in a savings account could help pay for a surprise car repair or medical bill. You can always set a new goal once you reach your initial target.

To build your emergency fund, consider setting up automatic transfers from your paycheck or using mobile technology to save automatically each time you make a purchase. You can also save your tax refund or adjust your deductions so that you have less money withheld and can contribute more to your emergency fund.

Frequently asked questions