This Is the Only Type of Account I Trust for My Emergency Fund

Building an emergency fund is one of the first steps toward financial security. By having money saved for emergencies, you’ll be able to cover those surprise expenses without needing to put them on your credit cards.

When fully funded, your emergency fund will be a significant amount of money. The rule of thumb is to save enough to cover three to six months of living expenses. If living expenses are $5,000 per month for your household, your target emergency fund would be $15,000 to $30,000.

With any type of savings, it’s important to choose the right type of account. This is especially true with emergency savings, as it needs to be secure and accessible at a moment’s notice. And considering the amount you’ll be saving, getting a competitive interest rate on it would be helpful, too.

There are lots of places you could keep your emergency fund. But the only place I trust with mine is a high-yield savings account.

High-yield savings accounts are perfect for emergency funds

A high-yield savings account is a savings account with a generous APY. Most of them are available with online banks. Since these banks don’t have the overhead costs of running branches, they can pay much more interest to account holders. Some of the best high-yield savings accounts currently have rates above 5%.

Other than a higher APY, these accounts work just like any other savings account. They keep your money safe, and you can make withdrawals from them at any time. Most of them don’t include a debit card, so you can’t make withdrawals from an ATM. But you can transfer money to a checking account to use it for paying bills or cash withdrawals.

With their benefits, high-yield savings accounts have everything I want in an account for my emergency fund. Here’s a rundown of why I recommend using them:

• They keep your money safe: Most high-yield savings accounts have FDIC insurance covering up to $250,000 per eligible account ($500,000 for joint accounts). You can check if a bank is FDIC-insured on its website or by contacting its customer service.
• You’ll have easy access to your money: You can withdraw your money at any time. Some savings accounts have monthly withdrawal limits, but not all of them, and the limit is always at least six withdrawals per month.
• Your savings will earn a competitive APY: If you have a $15,000 emergency fund in an account with a 5% APY, it will earn $750 per year in interest.

What about other types of accounts?

Finding the right place for an emergency fund is a frequent topic of discussion. Some people go with other bank accounts, such as certificates of deposit (CDs) or checking accounts. Those who want a higher return may even invest their emergency funds through brokerage accounts.

Here are the pros and cons of these options compared to high-yield savings accounts.

CDs

With a CD, you lock up your money for a set amount of time and get a fixed interest rate. The highest CD rates are normally a bit higher than what high-yield savings accounts offer, so you can earn more this way.

Since CDs have fixed interest rates, you’re also guaranteed that interest rate for the term of your CD. With a savings account, the rate can rise or fall at any time.

The one big drawback with CDs is that you can’t withdraw your money at any time. If you need to withdraw money before the CD’s maturity date, you’ll pay an early withdrawal penalty. That’s why I don’t recommend them for emergency savings, because you never know when you’ll need it.

Checking accounts

Some people keep all their savings in their checking account. While you can do this, it’s not optimal, and a checking account definitely isn’t the place for an emergency fund.

The top checking accounts are great for managing your money, and some of them also earn interest. But they have much lower rates than what’s available with high-yield savings accounts.

Also, it’s hard to keep your savings organized when you have it all in your checking account. The money you use to pay your bills will be mixed up with your emergency savings. That could mean you accidentally end up spending money from your emergency fund.

Brokerage accounts

Investing is one of the best ways to make your money grow. Case in point, the S&P 500 grew by 24.23% last year. When you have a lot of emergency savings, it’s tempting to put it in the market in hopes of earning more than you would with a savings account.

This is a common mistake people make with their emergency funds, and it can be a costly one. Investing in stocks has historically been a smart way to build long-term wealth. But on shorter timelines, the stock market can be highly volatile. The S&P 500 may have delivered spectacular returns in 2023, but in 2022, it lost 19.44%.

That’s fine when you’ve invested money you don’t need in the near future, because you can wait for the market to rebound. It’s a huge problem if you have an emergency, and your $10,000 emergency fund is now worth $8,000. You could be forced to sell at a loss in this situation.

It takes time and discipline to build an emergency fund. Don’t stash yours just anywhere. I use a high-yield savings account for mine, and that’s what I recommend to everyone I know, as well.

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