Emergency Fund Strategies: Where To Invest For Peace Of Mind

Emergency funds are a necessity for everyone. They are a safety net to protect you from the financial shocks that life can throw your way, such as a broken bone, a car accident, or losing your job. Experts recommend that you put aside enough to cover three to six months' worth of living expenses. But where should you keep your emergency fund?

There are several options to consider, each with its pros and cons. You could keep your emergency fund in a traditional bank savings account, which offers high liquidity but low interest. Or you could invest it in stocks, property, or other higher-risk, higher-reward assets. However, investing your emergency fund is generally not recommended, as you run the risk of losing money, and you may not be able to access your funds quickly in an emergency.

A good compromise is to put your emergency fund into a high-yield savings account or money market account, which will earn you a higher rate of interest than a traditional savings account, while still allowing easy access to your money.

High-yield savings accounts

You can open a high-yield savings account at an online bank. However, you won't be able to walk into a branch to withdraw funds. You'll need another bank account to transfer money in and out of your high-yield savings account, which could cause a delay in receiving funds during an emergency. When considering a high-yield savings account, look at the interest rates, fees, perks, and rules concerning withdrawals.

While interest rates offered by most high-yield savings accounts have held steady at 0.5% for the last 18 months, it's still better than nothing, and you know that the value of your money won't fluctuate. For example, Marcus by Goldman Sachs High Yield Online Savings offers 4.50% APY, and Ally Online Savings offers 4.20% APY.

Money market accounts

One of the significant benefits of money market accounts is their liquidity. Many of these accounts come with debit cards and/or check-writing privileges, giving you instant access to your funds. You can also make a certain number of free withdrawals each month. This feature ensures that you can quickly cover unexpected expenses, such as medical bills or car repairs, without incurring additional costs or penalties.

However, it's important to note that money market accounts may have some potential drawbacks. Some accounts have minimum balance requirements, which could be considered a positive incentive to maintain your emergency fund. There may also be fees associated with these accounts, and they could have limited monthly withdrawals.

When choosing a money market account, carefully consider the fees, minimum balance requirements, and withdrawal limitations to ensure it aligns with your financial goals and needs. Overall, money market accounts offer a safe and accessible option for your emergency fund, allowing you to earn interest while maintaining easy access to your money.

Certificates of Deposit (CDs)

One important thing to consider about CDs is that they require you to keep your money in the account for a specific period, known as the "term". The term can be as short as a month or as long as five years or more. If you withdraw your money before the term ends, you will usually have to pay an early withdrawal penalty. This could be a flat fee or a percentage of the interest earned.

To avoid this penalty, you can create a CD ladder. This strategy involves buying several smaller CDs with different maturity dates, instead of a single large CD. This allows you to increase liquidity and avoid or minimise early withdrawal penalties. For example, you could have one CD with a three-month term, another with a 12-month term, and another with an 18-month term, and so on. This way, you always have some funds that are accessible without penalty.

When choosing a CD, look for No-Penalty CDs, which allow you to withdraw your money without losing any of the interest you have earned. These may offer a slightly lower interest rate, but your funds will be more liquid.

CDs are a good option if you want to earn a higher interest rate on your emergency fund while still keeping your money relatively safe and accessible.

Traditional bank accounts

Accessibility and Liquidity:

Safety and Security:

Stability and Peace of Mind:

With a traditional bank account, you know exactly how much you have saved and can access it at any time. This stability and predictability are crucial for emergency funds, ensuring you can handle unexpected expenses without worrying about market fluctuations or complex withdrawal processes.

Interest Earnings:

While traditional bank accounts may offer lower interest rates than some alternative investments, they still provide a modest return on your savings. The interest earned can help offset the effects of inflation and keep your emergency fund growing slowly but steadily.

Separate from Other Accounts:

It is recommended to keep your emergency fund separate from your everyday spending and savings accounts. By placing it in a traditional bank account, you create a mental barrier that makes you think twice before withdrawing from your emergency fund for non-essential purposes.

Convenience and Trust:

In summary, traditional bank accounts offer a combination of accessibility, stability, and security for your emergency fund. While the interest rates may be modest, the peace of mind of having readily available funds during unexpected events is invaluable. Remember to shop around for the best rates and consider opening an account at a different bank to reduce the temptation of unnecessary withdrawals.

Roth Individual Retirement Account

A Roth Individual Retirement Account (IRA) is a savings tool that offers a way for workers to save for retirement, home ownership, or other purposes. It is also useful for people who participate in an Individual Development Account (IDA) program.

With a Roth IRA, you contribute after-tax dollars, meaning you've already paid taxes on the money you put into the account. While there are no current-year tax benefits, your contributions and earnings can grow tax-free, and you can make tax-free and penalty-free withdrawals during retirement, provided you are 59 and a half years old or older, and the account has been open for at least five years.

There are no age restrictions on contributions to a Roth IRA, and you can leave amounts in the account for as long as you live. Additionally, there is no requirement to take minimum distributions, unlike with a traditional IRA.

The main benefit of traditional IRAs is that contributions can be subtracted from taxable income, which could lower the amount of tax owed. However, many workers with lower and moderate incomes don't need this benefit because they don't earn enough to owe income taxes.

Roth IRAs can be a good option for those who expect to be in a higher tax bracket in the future, making tax-free withdrawals advantageous. However, there are income limitations to opening a Roth IRA, so not everyone is eligible for this type of retirement account.

Frequently asked questions