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How to Determine Where to Keep an Emergency Fund

How to Determine Where to Keep an Emergency Fund
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We would all like to believe that we’re financially secure and that we will have a healthy income until we retire. But life has an annoying habit of throwing you the odd financial curveball from time to time. Inevitably something comes up that leaves you wondering how you’re going to make it through.

Because financial futures are so uncertain, it pays to keep an emergency fund. The purpose isn’t to generate a massive return, but to provide you and your family with a source of cash that is separate from your central investments. Ideally, you want something that you can access quickly and easily, without having to cash out of your other, long-term investments.

We will dive into how much money you need to stash away and where to keep your emergency fund.

What Is An Emergency Fund?

First things first, you need to understand exactly what an emergency fund is.

An emergency fund might have various names, but there is one crucial aspect to keep in mind – it’s money set aside for unforeseen circumstances. It might be to pay an unexpected medical expense or to help a family member in trouble. The fact remains that it’s for an emergency.

When the unexpected happens, it is usually accompanied by personal hardship. Therefore, it’s essential to keep some easily accessible funds tucked away because life is unpredictable, and you never know what situation might pop-up. You want to be able to focus on the important things like feeling better or helping out a family member without stressing out about the financial ramifications.

Building an emergency fund and getting out of debt are two of the initial steps to getting your life together financially on the road to financial independence and early retirement.

6 Best Places To Keep An Emergency Fund

An emergency fund can come in handy, but it is critical to store it in the right place.

You’ll need to ensure that you have quick access while keeping it separate from your regular spending accounts. After all, this money is for emergencies only. You don’t want to spend your emergency fund accidentally, so consider your options carefully.

1. Cash

The most liquid place to keep your emergency fund is in the form of cash. Here you either leave your money in a savings account or keep it in a coffee can – or a bit of both – and then leave it there until you need it.

Cash has the advantage of being easily exchanged for the stuff you might need in an emergency (such as repairs to your car, medical care, legal expenses, and so on). You don’t need to cash out of any investments or pay any penalty fees for withdrawing money earlier than specified in any contracts. It’s infinitely fungible and exchangeable.

There are, however, two significant downsides to cash. The first is security. Keeping a large amount of uninsurable cash on your property puts you at risk of losing a large sum of money to theft. Furthermore, a run on the bank, as happened in the 2008 financial crisis, could lead to your deposit being wiped out, along with everyone else’s.

The second issue has to do with inflation. The general rise in the price level means that your money loses about two percent of its purchasing power every year – not good! Thus, you need to top it off to maintain its value.

Luckily, there are alternatives to cash if you aren’t comfortable with this option.

2. High-Yield Savings Account

The term “high-yield savings account” is a bit of a misnomer for the majority of savings accounts. 0.1 percent interest might be high compared to a regular checking account, but it’s not exactly a homerun investment.

In this sense, a high yield savings account is similar to cash. You wind up losing the value of your money to the power of inflation.

However, some savings accounts offer rates of interest that keep pace with inflation, providing you with far better overall performance (meaning that you don’t need to top off your savings accounts every year).

CIT Bank, for instance, offers an account that allows savers to earn up to 2.10% APY and doesn’t fluctuate with the market.

Interested in depositing your emergency fund in CIT Bank? Click here for more information

3. CD Ladders Without Early Termination Fees

CDs or “certificates of deposit”are a kind of time account that offers a high rate of interest in exchange for you NOT accessing your money for a given amount of time. Typically, the length of time you agree not to access your funds ranges from thirty days to ten years.

CDs might not sound like a particularly sensible instrument to use for an emergency fund, but they have a saving grace: something called a CD ladder.

The majority of CDs have early termination fees. In other words, if you try to withdraw money before the end of the term, the provider will charge you a fee, cutting into any interest you accrue. A CD ladder, however, helps you avoid this problem.

Instead of plowing all of your money into a single CD, you put it into multiple CDs of varying lengths. So, for instance, you could put money on a rolling basis into three-month, six-month, and twelve-month CDs. Then, if disaster strikes, you’re usually within shouting distance of accessing your money. One solid strategy is to put chunks of cash into rolling 30-day CDs, providing you with available funds at the end of varying 30-day periods, running throughout the month. You could arrange maturities every week if you decide to go that route.

The plus side of CDs is that your money is working for you. The downsides are the fees and the fact that any individual maturing CD might not be able to cover the immediate costs of your emergency.

4. Money Market Account

A money market account is a lot like a savings account but with a few extra bells and whistles. Like a savings account, you get paid interest into your account every month or so. But you also get a host of additional features that you’d usually find on a checking account, like a debit card and check-writing capabilities.

Money market accounts can be slightly more lucrative than high-interest saving accounts if your emergency fund is relatively large. Some options pay you a higher rate of interest-based on the amount of money that you deposit into the account. But the thresholds can be substantial, and perhaps well above what you might reasonably put away for a rainy day.

If you want to open a money market account, you may have to put up with higher minimum balances. If you don’t have a chunk of cash ready to go immediately, this feature of these accounts can be an obstacle to your savings.

5. Treasury Bills

Treasury bills are short-term debt obligations. When you buy a Treasury bill, you’re lending the government your money and receiving a certificate in return that promises to pay you the initial sum, plus a bit of interest on top.

Many commentators consider US Treasury bills to be the safest financial instrument around. Economists often call them the “risk-free assets” because the government can take extraordinary measures to pay the coupon, like printing money.

But does it make an excellent place to put an emergency fund?

On the plus side, it is incredibly safe. The US government has never defaulted on its debt obligations to investors in the past, and probably won’t in the future.

What’s more, you don’t have to wait until maturity to sell a Treasury bill. There are plenty of people in the financial markets who are willing to buy Treasury bills from you. Thus, if you find yourself in financial trouble, you can call your broker or open your investing app and sell, usually at a moment’s notice. However, you may lose some of the value if you choose to sell early.

The interest rate on Treasury bills varies depending on the time to maturity. Under normal economic circumstances, short-term Treasury bills have a lower rate of interest than long-term Treasury bills.

So, for instance, a 3-month Treasury bill might have an annualized interest rate of 2 percent, while a 30-year Treasury bill might have a rate closer to 6 percent.

Longer maturation Treasury bills tend to have higher interest rates because of the increased uncertainty in the prevailing time period. Prices could go up much faster in the future, for instance, necessitating a higher rate of interest to maintain the value of the bond.

Overall, bonds can be a solid investment, but it may not be the most effective place to store your emergency fund. You’ll need to decide for yourself if you want a more easily accessible place to store your emergency fund.

6. Roth IRA

A Roth IRA is most commonly used for retirement funds and pension schemes, but one can double up as an emergency fund. What happens is that your savings are invested in the market, and you get a cut of the returns. Therefore, the growth rate could be pretty spectacular or dismal based on the market.

Although qualified withdrawals are tax-free one-hundred percent of the time, not all emergencies are qualified withdrawals. Nonqualified withdrawals, even emergency ones, incur a 10% penalty. Also, depending on how long you’ve had the account and your age, the savings might be taxable.

Best Places to Keep an Emergency Fund

A Roth IRA might not be the best avenue for emergency savings, but it can be liquidated fairly quickly with possible various penalties if you are in desperate need of cash.

How To Build Your Emergency Fund

Deciding where to keep your emergency fund is important. However, you’ll need to build an emergency fund to store. Without the cash on hand, the question of storage becomes less useful.

Here’s how you can build your own emergency fund:

Decide How Much To Save in Your Emergency Fund

An emergency fund is there as a fallback solution if life throws some unexpected expenses your way. The amount you decide to save is a very personal decision based on your employment situation and your risk tolerance.

If you have a solid W2 income that doesn’t fluctuate and a high risk tolerance, then your emergency fund will be on the lighter side. If you have a low-risk tolerance and a fluctuating income, then your emergency fund will likely be heftier. In either scenario, your lifestyle costs will also play into the final number.

Generally, it is recommended that you save at least 3 to 6 months’ worth of expenses in your emergency fund. If you are self-employed or have a low-risk tolerance, then consider saving more. You want to have a buffer between an unexpected expense or job loss and running out of easily accessible money.

Take a look at your budget to find out what your emergency fund should look like.

Choose The Best Account For Your Situation

As discussed earlier, you have many options for where to keep your emergency fund.

The most important thing is to disconnect your emergency fund from any existing savings. The account that holds your emergency stash should be somewhat out of reach so that you can’t spend it accidentally. Of course, it should be easily accessible but not so easy that you spend it without even realizing it.

No one has the same exact financial situation, so the final decision will depend on your risk tolerance and your current finances. Take a minute to consider your options before moving forward with a single course of action.

Slow and Steady

Once you have a number in mind, it is time to start saving towards that goal!

One method to try is setting up automatic payments that go into your emergency fund every month. You can build the account slowly without forcing yourself to make the right decision each month. If money is already tight, then consider picking up a side hustle with the intent to build your emergency savings.

Remember, every penny you are able to stash now could save you from financial catastrophe in the future.

Our Debt Thermometer Printables include a BONUS emergency fund printable that you can use to make a goal and track your progress! Check them out here.

The Bottom Line: Decide Where to Keep Your Emergency Fund

Ultimately, you need a rainy day fund that can protect you from financial disasters, such as breaking up with a partner, losing your job, or facing a large, unexpected bill. Here, we’ve outlined some of the options available to you, each with various pros and cons. Overall, you want two things: accessible money and the ability to shield it from inflation.

Where will you keep your emergency fund? Let us know in the comments!

Bo @ The Dollar Blogger

Saturday 21st of March 2020

My personal favorite place to keep an emergency fund is an online savings account. You generally get some of the best interest rates, the money is FDIC-insured, and it's safe.

Everyone definitely needs an emergency fund, even if they only start with $1,000 and then later work to save up to 6 months of expenses. -Bo

A Dime Saved

Wednesday 20th of November 2019

These are all great options for an emergency fund. The most important thing is to just have it! Life happens and having money set aside to deal with it is a game-changer!

Sam @ How To FIRE

Thursday 21st of November 2019

Thanks so much for reading! I couldn't agree more - having an emergency fund has not only come in handy but it's given us peace of mind.