Life has its difficulties; things happen. What would happen if you suddenly lost your job? Do you have enough savings to cover necessary expenses to keep you and your family afloat until you find a new job? Job loss on top of a million other possible emergencies is the reason why everyone needs to have an emergency fund tucked away.
Nearly 25% of Americans have no emergency savings, and almost half of Americans could only handle a $1,000 emergency by dipping into savings. You need a place where you can safely keep and build your emergency cash. We’ll explore the best way to keep an emergency fund and the pros and cons of each.
What’s the Best Way to Keep an Emergency Fund?
The best way to keep an emergency fund is to separate it from your other regular checking and savings accounts. If you’re looking for the best way to keep an emergency fund — besides hiding it under the mattress — consider these savings vehicles.
High-Yield Savings Account
A high-yield savings account is a bank account where you can deposit money and typically earn a higher interest rate on your deposits. So what does this mean? It means a better return on your deposits. The interest rate is what the bank pays you to keep your money in that account.
Some banks may require you to make large deposits to open a high-yield savings account. In addition, you might have to maintain a large balance to avoid fees, earn interest, or keep your account open. If you’re interested in a high-yield savings account as the best way to keep an emergency fund, make sure it’s an account that offers the best return with little to no effort on your end.
Here are possible advantages and disadvantages:
Pros
- Potential for better returns
- Funds are easily accessible
- Funds can be transferred quickly between linked accounts
- FDIC-insured bank or credit union offers safety
Cons
- Check-writing limits
- Not an ideal investment with 1-2% rates
- Online only
- Higher interest rates normally have a cap after which you won’t earn interest on the higher rate
Money Market Account
A money market account is like a high-yield savings account, but it has features similar to a checking account. It generally comes with checks or a debit card with a limited number of monthly transactions. A money market account is a deposit account that pays interest based upon current interest rates.
Possible advantages and disadvantages:
Pros
- Depositing funds or transferring money between linked accounts offers convenience and flexibility.
- Because of checking account features, funding a large expense can be done quickly with little stress.
- Interest rates are competitive, similar to a high-yield savings account.
- You get safety and security with an FDIC-insured bank or credit union.
Cons
- Some banks may have a higher minimum balance requirement.
- While some accounts might offer great rates, others may offer an APY similar to a traditional savings account. Another possibility is having to qualify for a higher rate by first meeting a certain minimum balance.
- Banks can charge monthly maintenance fees for having an open account, but it may be possible to waive the fee by meeting daily balance or direct deposit requirements.
- While these accounts are subject to federal Regulation D limits, which is six withdrawals per month, banks can impose in-house limits.
Certificate of Deposit
Certificates of Deposit (CDs) are typically issued by commercial banks that restrict access to invested funds but offer much higher interest rates. When you open a CD, you must choose a specific period. Terms can range from three months to five years, with longer terms usually offering higher rates. If money is withdrawn before the end of the term, there are typically penalties.
Here are potential pros and cons of using a CD as the best way to keep an emergency fund:
Pros
- CDs are offered through FDIC-insured banks and credit unions.
- They offer better returns than savings deposits.
- Fixed, predictable returns; CDs deliver a specific yield within a certain period.
- A wide selection of terms exists to help investors choose a term that best suits their needs.
- A wide selection of account options exists, such as no-penalty CDs that allow savers to get a better interest rate with the option to close the account with no penalties.
Cons
- Because of limited liquidity, savers may have difficulty accessing funds in a time of need and usually have to pay a penalty for early withdrawal.
- Because rates are fixed, there’s a risk of inflation.
- Returns are typically lower than other higher-risk asset classes.
- There’s reinvestment risk with CDs. When interest rates are going down, savers who locked in a rate will need to invest in lower-yielding CDs when their CD matures.
- Savers must pay taxes on accrued interest.
Traditional Bank Account
We can add traditional bank accounts to the list of best ways to keep an emergency fund. Here are a few pros and cons of traditional accounts:
Pros
- They are easily accessible and can be withdrawn at any time.
- You can access your account online or go to a brick-and-mortar bank or credit union, depending upon which one you choose.
- Your money is safe with FDIC-insured banks or credit unions.
Cons
- Traditional accounts are low-yield, and you won’t see the same return as with other account types.
- Interest earned is taxed as ordinary income.
- It’s easy to withdraw money at any time, even when it’s not an emergency.
Best Way to Keep an Emergency Fund
There’s no single best way to keep an emergency fund, and regardless of what you decide, you can always choose more than one option. Allocating money to different accounts gives you multiple options for financing your emergency.
