Investing Your Emergency Fund – Ways to Increase Savings
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An emergency fund is the amount you save for a rainy day. You might have already faced obstacles or emergencies in life that require immediate cash. It could be a roofing problem in your home or an emergency medical expense. Such events can catch you off guard, and you could be in financial trouble if you don't have a fund set aside. Nobody can predict the next emergency, but you can always prepare for it. Building an emergency fund is the right way to deal with the troubles that life throws at you. But what do you do with the fund, and where do you keep it? We can help you find the best ways to invest your emergency fund.
In this article
Where to invest your emergency fund?
An emergency fund is a crucial financial safety net designed to cover unexpected expenses or financial setbacks, such as medical bills, car repairs, or job loss. The primary purpose of an emergency fund is to provide quick access to cash when you need it the most, so safety and liquidity are paramount when considering where to invest your emergency fund. Here are some options to consider:
High-yield savings account (HYSA)
This is one of the most popular choices for an emergency fund. It offers higher interest rates than regular savings accounts while keeping your money easily accessible. Look for accounts with no or low fees. You can easily find high-yield accounts in brick-and-mortar and online banks. Compared to a traditional savings account, a HYSA is quite reasonable and will allow you to enjoy a higher interest rate. Many banks have no minimum balance requirements and do not charge any monthly fees. Most accounts can earn over 2.00% APY based on the funds. It is also a highly secure option since the account is FDIC-insured, and there is no chance of losing your money. Look at the rates whenever you open an account and pay attention to the fees. If you are saving for a specific goal, putting aside the money in a high-yield savings account will ensure you earn interest until you need it.
Related: Best High-Yield Savings Accounts
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Money market account
Money market accounts typically offer slightly higher interest rates than regular savings accounts. They often come with check-writing privileges, making it easier to access your funds in an emergency. Money Market accounts are similar to HYSA and come with a debit card, making them ideal for regular use. However, they have a higher minimum deposit requirement, and some also have tiered interest rates that depend on the account balances. A money market account can be opened at online banks and local banks. It helps to compare the rates before opening the account. There will be a limit on the number of withdrawals you can make each month. The maximum allowed is six per month, and if you exceed the limit, you will have to pay a fee.
Traditional savings account
Most of us have a checking and savings account with a traditional bank, and putting your emergency fund in the same is very convenient. You can withdraw from the account anytime, but the interest rate will be very low. This might be a good option if you are only looking for a safe place to stash your emergency fund and want high liquidity. You will only earn a few pennies each month, but it is much better than not having enough liquidity with your money. Banks will charge a monthly maintenance fee, which can be waived if you maintain a certain balance or make a predetermined number of direct deposits.
Certificates of Deposit (CDs)
Another alternative to investing your emergency fund is in a CD. However, it will require you to keep your money in the account for a certain period, and if you withdraw before its maturity, you could end up paying a penalty. CDs offer higher interest rates than regular savings or money market accounts but have a fixed term (e.g., 6 months, 1 year, 3 years). In exchange for the higher interest rate, you agree only to withdraw the money once the CD matures. Consider creating a "CD ladder" with different maturity dates for flexibility. Investing your money in a CD comes with a risk. If you need your money before maturity, you could end up with an early withdrawal penalty, which will reduce the earning amount. There are no-penalty CDs, but you will have to compare the rates to ensure you are choosing the right one. A CD account can be opened at any brick-and-mortar or online bank. Some do come with minimum deposit requirements.
Short-term treasury bonds or bills
U.S. Treasury bonds and bills are considered very safe investments. While they are less liquid than savings or money market accounts, they can be a viable option for a portion of your emergency fund, especially if you're comfortable with a slightly longer access time. A low-risk and highly secure investment, you can buy T-bills through a brokerage or the Treasury Department. The bill is auctioned using a competitive and non-competitive process. They are usually held till the maturity date, but many sell the bill before maturity and realize short-term gains. It comes with a maturity ranging from a few days to a year. You will not earn regular interest on the T-Bill, but it will be paid at maturity with the face value.
Roth IRA
While not typically recommended as a primary emergency fund location, a Roth IRA can serve as a last-resort source of funds. Roth IRAs allow you to withdraw your contributions (not earnings) without penalties or taxes. Even if you keep the money in a high-yield savings account, it might need to earn more interest to keep up with the rising inflation. But a Roth IRA can probably earn you more money. However, it comes with a risk as the Roth IRA could lose value, and it is best to opt for more conservative investment options to reduce the risk of loss.
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Factors to consider before investing
When deciding where to invest your emergency fund, consider these factors:
- Liquidity. Ensure that you can access the funds quickly without penalties or waiting periods.
- Safety. The primary goal of an emergency fund is to protect your money, so choose low-risk options.
- Return. While safety is crucial, you should still seek options that provide some return to at least keep up with inflation.
- Accessibility. Make sure you can access your funds when needed without excessive restrictions or fees.
The ideal choice for your emergency fund may vary depending on your risk tolerance, financial goals, and the size of your fund. It's often recommended to have 3 to 6 months' worth of living expenses in your emergency fund or more if you have specific circumstances, like a volatile job or irregular income. Diversifying your emergency fund across different options can also be a strategy to balance liquidity and return potential. Consulting with a financial advisor can provide personalized guidance based on your financial situation.
Pros and cons
Pros
- Potential for Growth. Investing your emergency fund in assets like stocks or bonds may offer the potential for higher returns compared to a traditional savings account or a low-yield money market account. Over time, this could allow your emergency fund to grow more substantially.
- Inflation Hedge. Keeping your emergency fund in a regular savings account may lead to a loss of purchasing power due to inflation. Investing can help counteract this erosion by earning a return that outpaces inflation.
- Increased Liquidity. If you invest in relatively liquid assets like stocks or ETFs, you can typically access your funds within a few days if an emergency arises. This can be quicker than trying to withdraw from certain types of savings accounts, especially if there are withdrawal limits or penalties.
Cons
- Risk of Loss. Investing always carries the risk of losing money. If you invest your emergency fund and the market experiences a downturn, you may need to access the funds when the market is down, resulting in losses that could have been avoided by keeping the money in a safer, liquid account.
- Market Timing Risk. There's a risk that your investments could be down when you need to tap into your emergency fund. If you're forced to sell investments during a market downturn, you might lock in losses.
- Short-Term Volatility. Investments like stocks are subject to short-term price fluctuations. If your emergency arises during a market downturn, you might need to use your emergency fund when your investments are at a low point.
- Lack of Guarantees. Savings accounts and money market accounts are typically insured by the FDIC (in the U.S.) up to certain limits, providing a level of protection that investments don't offer. This guarantee ensures that you won't lose your principal, even if the bank fails.
- Tax Implications. Depending on the type of investments you choose and the duration of your investment, there may be tax consequences when you need to access your funds. Gains on investments held for less than a year may be subject to short-term capital gains tax, which could reduce the amount available for your emergency.
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3. Save effortlessly. Ready to save? Just click Capital One Shopping and the best deal discovered will be applied to your cart.
Should you invest the emergency fund in stocks?
Investing your emergency fund in stocks, mutual funds, or cryptocurrency is not advisable. This is because they are high-risk investments and you could lose your money. Your emergency fund has to remain secure and easily available at all times. Whenever an investment relies on the market, there are chances of losing your money, and this is not something you want with your emergency fund. However, if you already have a significant amount saved, you can put some money in stocks, but there will be volatility, and you should be prepared if you face a loss. Also, since stocks typically take a long time to move upwards, you might need more time to access the cash.
The bottom line
In conclusion, investing in your emergency fund should be based on your financial situation, risk tolerance, and time horizon. Generally, it's advisable to keep at least a portion of your emergency fund in a readily accessible, low-risk account to ensure you have funds available when needed. If you choose to invest a portion, consider your risk tolerance and the potential impact on your ability to cover unexpected expenses. Diversification and a long-term investment approach can mitigate risks associated with investing in your emergency fund. It's also wise to consult with a financial advisor for personalized guidance.
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Editor
Vandita Jadeja is a financial writer and editor at Joywallet. She loves to read and write about money and brings a decade of experience from the financial industry.
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