The economic tumble we witnessed in the past several years should convince us of the importance of having an emergency fund. As we have seen, markets, and life in general, are unpredictable. It’s smart to have some funds available in case you face an unforeseen financial problem. Unfortunately, although the market appears to be improving, there are not as many options as in the past for safe investments with moderate returns. But here are a few safe places to create your “rainy day” fund.
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If you’re a regular Moolanomy reader, you are likely aware of some of the benefits that the best online savings accounts offer. Some customers have turned to online banks to seek higher interest rates and to avoid fees associated with more traditional banks. If you are comfortable banking without physically interacting with a banker or teller, you might want to look at opening an online savings account as an emergency fund.
Online banks are typically able to offer better interest rates because they reduce costs associated with maintaining physical buildings and normal business operations. They also tend to have superior websites than traditional banks because practically all your interactions with the bank are done online. There are certain negative aspects — you can’t go into a branch and you need internet access to perform financial transactions. However, since you can access your funds via an ATM, an online savings account is an excellent option for an emergency fund. When you look at online banking options, check out specific account options along with the interest yield. Also, of course, verify that the bank is FDIC-insured.
A money-market account (MMA) is a high-yielding savings account offered by an FDIC-insured institution. Make sure you don’t confuse a money-market deposit or savings account with a money-market mutual fund, sometimes just called a money-market fund. A money-market fund is required by law to invest in safe assets like low-risk securities, but it is not FDIC-insured. We do not recommend using a money-market fund for your emergency fund because of this lack of insurance.
With an MMA, you have easy access to cash, while receiving a relatively high interest rate. Your debit card connected to your MMA generally allows you to withdraw money at ATMs or charge purchases. An MMA will very likely come with a minimum balance requirement and limitations on the number of checks you can write and withdrawals you can make each month. But since you will be using your MMA as an emergency fund, these conditions shouldn’t be a problem.
Credit unions have become increasingly popular in recent years. They are member-owned, not-for-profit financial organizations that offer many of the same services as banks. Since credit unions are not-for-profit, cooperative organizations, they are exempt from many of the state and federal taxes that traditional banks must pay. As a result, accounts at credit unions usually see much better interest rates. Each account is insured up to $250,000 by the National Credit Union Administration. Opening a credit union account as an emergency fund could be a very attractive option.
This option may surprise you. The money you add to a prepaid debit card, while FDIC-insured, does not pay interest. But some cards now offer a high interest savings account linked to the prepaid card. The best offer I’ve seen is from the Mango prepaid MasterCard, which offers a whopping 5.1% APY savings account option. You are limited to no more than $5,000, but that’s perfect for an emergency fund. You do have to set up direct deposit to the card to qualify for the savings account, but that’s a great way to automate your savings.
A certificate of deposit (CD) is traditionally one of the safest places to store your cash and receive a small, though predictable rate of return. Some of the best high yield CDs might fit well in your overall investment strategy, but we don’t recommend using most CDs as an emergency fund because they do not allow you to easily withdraw your money. A CD has a maturity date, and if you withdraw your funds early you typically have to pay a penalty in the form of an early-withdrawal fee. Your emergency fund should instead provide easy and instant access to cash.
There are two possible exceptions. First, there are some no-penalty CDs that allow you to take out your cash before the term of the CD expires without penalty. And second, the Ally Bank 5-year CD limits the penalty to just two-month’s worth of interest. Giving the higher rates that a 5-year CD pays, this relatively small penalty just may be worth the risk.
In a world where plastic credit cards dominate, it might seem outdated and silly to store physical cash in your home. Then again, if it gives you some peace of mind to have cash immediately available, you should at least try to hide the money out of sight. Here are a few options (hopefully thieves aren’t regular Moolanomy readers!):
With all these options, be sure to tell a close friend or spouse about your secret hiding place in the unfortunate case that you die or somehow can’t reach the money.