Having a rainy day fund is such an important aspect of feeling financially secure. Even if you have mountains of debt, having just the smallest nest egg squirreled away can make a huge difference to your bottom line and your sanity. But where should you keep that safety net? Should you just let it sit in your checking account untouched? Here are several options to help you maximize your emergency fund.
Keep a Small Amount Really Liquid
We often talk about emergency funds as a total amount, but in reality I typically recommend that my clients maintain two separate emergency funds. One fund should be really liquid, meaning you can access the money almost immediately while the other can take a few days to access. Keeping this amount limited is key, however, because what you don’t want to do is spend that money for things other than absolute emergencies. I recommend keeping about $1,000 in a savings account that is directly linked to your checking account. For instance, if your checking account is with Wells Fargo, your savings account should also be with Wells Fargo. This will allow you to make instant transfers if an emergency ever does come up, but also allows you to replenish the funds quickly whenever you must utilize them.
Calculating the Remainder
The remainder of your emergency fund should cover you for 3-6 months of expenses. If your job is fairly stable a three month fund may be sufficient. If your career prospects are more limited and finding a new job is a bit tricker, a six month runway might be a better option. When you’re determining how much you need also keep two things in mind. First, you don’t have to base it off of your current expenses. You can base it off of a standard of living that is lower than your usual spending as long as it is a standard that you would be able to sustain for a few months. I don’t want anyone starving here, but maybe a few happy hours could go out the window. Next, remember that something is better than nothing. Often clients will feel overwhelmed with just how much needs to be in their emergency fund in order to be “fully funded”, and as a result they will give up before they even try to fund it. I know it seems like a lot and not a particularly sexy thing to do with your money, but even a little bit can go a long way when it comes to having a safety net.
Stashing the Remainder
So where exactly should you put the remainder of your emergency fund? At the end of the day you want to get at least some return for your money without making it completely inaccessible. There are a couple financial tools that will let you do that.
A Savings Account: While a traditional savings account is a good place for a small part of your emergency fund, the return (or interest) you will get back on your investment will be nominal. If you choose to park the rest of your money in a savings account, investigate online savings accounts such as that offered by Capital One 360. Often the interest rates they offer are significantly higher than your brick-and-mortar bank. Your money is also insured by the federal government, so you will never get caught without an emergency fund.
Certificates of Deposits (CD): Along the same line as a savings account, a CD can be a good option if you’re looking for a very secure investment. While the interest rates are still typically low, they do rise the longer your term is and the higher your amount invested is. It is also insured by the federal government and typically offers higher returns than a traditional savings account. The downside is that your money is usually locked into the CD for a specific period of time, but you can usually make an early withdrawal with a small penalty, or even find a CD without a penalty (such as this one), though the interest rate will be lower on the latter.
Money Market Accounts (MMA): MMAs are almost a cross between as savings account and a checking account. Though terms vary between financial institutions, most will allow you to write up to six checks per month while still collecting an interest rate higher than that of a traditional savings account. While MMAs were more popular in the past, today the interest rates can often be lower than that of a high interest savings account such as the Capital One 360 saving account, so these accounts are being used less frequently.
Betterment: Betterment is an investment company that I really like for beginning investors because it allows you to easily choose how much of your investment is allocated to purchasing bonds, and how much is allocated to purchasing stock. Bonds are a really secure way to invest, as they typically payout dividends and interest without fail. Stocks, obviously can fluctuate greatly based on market conditions and company new. However, if you choose to invest part of your emergency fund with Betterment, you can specify that most of the fund is invested in bonds to minimize your risk, but still allow for some returns assuming the stock portion performs well. It should be noted that while the bond part of this investment is pretty stable, the stock investment is a more aggressive way to invest your emergency fund, so unlike savings accounts, CDs and MMAs, there is inherent risk that you may lose some of your initial investment. As a result, you may not want to invest your entire emergency fund with Betterment.
What Works for You
Overall, when you’re investing your emergency fund, you want to make sure that you’re doing what is right for you. Some people are more comfortable with risk than others. Some people can invest in a CD knowing they won’t need the majority of their money for years, while others may have much more uncertainty in their lives. Think about what works for you and consider the tradeoffs carefully.
Written By: Lindsay Dell Cook
Lindsay Dell Cook is a CPA, finance writer, and founder of Budget Babble. She lives in Philadelphia with her uber supportive husband and adorable daughter. When she's not working, she enjoys spending time with her family, taking their lovable mutt for walks, or reading a good book while buried under a pile of cats.