Keeping an Emergency Fund: 9 Tips for How to Do It
Do you have an emergency fund? Financial experts agree that having money set aside for unexpected events – like car repairs, medical bills, a job loss, or other emergencies – is a smart financial strategy. How much should you have in your fund? It’s recommended that you have enough money to cover three to six months of living expenses.
The next question is, where should you keep your emergency fund? You want ready access to cash when you need it, but you also want to keep your money secure. We’ll look at where you should – and shouldn’t – keep your emergency fund and options for growing your savings.
Keeping Your Emergency Savings Safe
Your emergency fund should be kept separate from your other savings. Setting aside money for unexpected events, especially through automatic transfers, lets you take control of your finances and gives you peace of mind. While it might be tempting to dip into your emergency fund for other needs, it should be used only for true emergencies. It’s not a vacation fund or backup cash for nonessential purchases.
3 Places You Shouldn’t Keep Your Emergency Fund
- At Home
While you don’t want to keep all your savings stashed at home, having some available cash is a good idea. In the event of an emergency, such as a natural disaster, you may not be able to get to an ATM, banking systems could be down, or you might not be able to use apps like Venmo or Zelle. Having cash can help you buy emergency supplies, gas, medicine, food, or other necessities. You don’t need to keep a ton of cash at home. A reserve of no more than $1,000 is recommended.
Don’t hide your cash under your mattress or in the cookie jar. Cash should be kept in a fireproof and waterproof safe, which can protect your money and other valuables from fire, flood, or other damage. Make sure, too, the safe is bolted down so it can’t be carried away in a burglary. You don’t want to be the target of theft, so only share information about your stash with people who really need to know about it.
- Checking Account
Your checking account is also a less-than-ideal home for your emergency fund. While the account comes with government insurance up to $250,000, you won’t be earning interest on your deposits. Because a checking account is so accessible with your debit card or checks, it’s easy to dip into it to cover regular expenses. Once again, your emergency fund should only be used for emergencies.
- Stocks & Bonds
While investing in stocks and bonds (including through mutual funds) is a good strategy for long-term investments such as retirement savings, it’s not the best plan for a shorter-term investment. Here are a few things to consider: If you purchase savings bonds, you won’t be able to cash them for a full year, and if you tap the fund in years one through five, you’ll lose a few months of interest. After five years, you don’t lose anything. Savings bonds make more sense for medium-term savings goals, such as a down payment on a house, where liquidity isn’t such a big concern.
3 Places You Should Keep Your Emergency Fund
- Savings Account
A savings account at your financial institution is a safe option, since all accounts are insured by the government up to $250,000 per depositor. You won’t earn much interest with a traditional savings account, but your money will be easy to access. You’ll earn a higher interest rate from a high-yield savings account.
- Money Market Account
A money market account earns higher interest than a traditional savings account and gives you access to funds through checks, debit cards, and online transfers when you need emergency cash fast. Money market accounts are also insured by the federal government for up to $250,000 per depositor, so you can count on your money being safe.
- Money Market Fund
While the name sounds like a money market account, the two are very different. Money market funds are investment securities, not bank accounts. They are a type of fixed-income mutual fund that invests in cash and low-risk, short-term debt securities. Money market funds tend to offer higher rates than money market accounts, but they are not insured by the government or protected if the financial institution defaults or files for bankruptcy. If you need money fast, you can generally receive it from the fund within a day.
3 Other Options for Where to Keep It
- Certificate of Deposit
When you put money in a certificate of deposit or share certificate, you’re saving for a set period. You’ll get a fixed rate of interest and can withdraw your money at the end of the term when the CD matures. You’ll earn higher interest rates than a savings account or money market account, and your rates are locked in for the entire term. CD terms generally range from three months to five years, and you’ll typically pay a penalty and forfeit interest if you withdraw money before the maturity date. If you’re interested in using this type of account for your emergency fund, look for no-penalty CDs. Also, you can do what’s called “CD laddering,” in which you open multiple CDs with different maturity dates. This helps you maximize interest while avoiding penalties.
- Roth IRA
Instead of keeping a more traditional emergency fund, you might want to consider investing in a Roth individual retirement account, which comes with tax advantages. With a Roth IRA, you can withdraw money at any time without paying taxes or penalties if you redeposit the funds within 60 days. However, if you miss that window, you’ll be required to pay an early withdrawal penalty as well as taxes. Keep in mind that while there’s the potential for greater returns, there’s also the risk that you could lose money. Selecting more conservative investment options can help lessen this risk.
- Treasury Bills
Treasury bills can be a good short-term investment strategy to build your emergency fund. Backed by the Treasury Department of the U.S. government, T-bills are safe, offer greater returns than traditional savings accounts, and allow you easy access to your money. T-bills are offered in short terms ranging from a few days to a maximum of 52 weeks (one year). Although interest is paid only at maturity, you can sell T-bills before they mature if an emergency arises and you need the cash quickly.
What Are Your Options for Keeping an Emergency Fund?
As you can see, you have lots of options when it comes to managing your emergency fund. Whichever you choose – savings account, MMA, MMF, CD, Roth IRA, T-bills – it’s important to have enough cash on hand so that you’re prepared when the unexpected happens.
Your financial institution can answer your questions and help you get started so that you can protect your future and keep your money safe.
