Dollar Scholar Asks: Where Should I Keep My Emergency Fund?
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This is an excerpt from Dollar Scholar, the Money newsletter where news editor Julia Glum teaches you the modern money lessons you NEED to know. Don't miss the next issue! Sign up at money.com/subscribe and join our community of 160,000+ Scholars.
Life is full of choices. Here's one I’m currently wrestling with.
Should I switch to oat milk in my coffee?
Alternative milks are everywhere these days, and meanwhile I’m still pouring half and half into my mugs like a nerd. I feel like I’m behind the times, but I’m not totally sold on oat milk actually being healthier than dairy. Plus, don’t I need calcium or something? (Is that for adults or only kids? Please advise.)
And that's not the only major decision I'm weighing at the moment. More importantly...
Should I move my emergency fund?
Experts generally recommend setting aside three to six months’ worth of basic living expenses in case of a rainy day. I’ve been chipping away at this savings goal, and now my emergency fund has finally reached a level that I’m comfortable with. But I’m beginning to think it’s in the wrong place.
Right now, I keep my emergency fund with my primary bank in a savings account I opened at the brick-and-mortar Bank of America branch in my hometown in, like, 2010. But the interest rate is downright insulting. I just looked it up, and my annual percentage yield, or APY, is 0.01%.
Shashin Shah, a CFP Board ambassador, confirmed that my money isn’t working quite as hard as it could be, especially given the current economic environment. The Federal Reserve has been raising interest rates for over a year now in hopes of curbing inflation. That has effectively made borrowing more expensive, but there's a silver lining for savers: Banks are ratcheting up rates on their savings accounts in order to compete for customers' deposits.
This is more evident among online banks than traditional ones because they generally have higher rates to begin with. For instance, since spring 2022, Ally has increased the APY for its high-yield savings accounts from 0.5% to 4.25%.
By keeping my cash in a basic savings account, I’m shooting myself in the foot. And that’s an expensive mistake to make: “If you're going from a 0.1% account to a 3 or 4% account, on $50,000 that's going to be a $2,000 decision — money that’s, for lack of a better word, free,” Shah adds. (I will have to pay taxes on that interest, but that’s a different issue.)
So, yeah, I gotta move it.
Somewhat paradoxically, he says the first thing I should do is to talk to my current bank. Old-school institutions like Bank of America tend to place a lot of emphasis on establishing relationships with their customers, so it’s likely they would welcome the opportunity to have me try another tool, like a money market account. All I have to do is ask.
“Most banks may have a solution for you that's in-house,” Shah says. “They just haven't connected the dots and made [it] available to you.”
Next, I should start shopping around, says Tiana Patillo, a financial advisor manager at Vanguard. This is the time to explore online banks in particular, looking for ones that will give “more bang for your buck,” she adds.
I can’t get totally starry-eyed over the yield, though. I still have to make sure the bank I ultimately select is backed by the Federal Deposit Insurance Corporation (or, if it’s a brokerage, that it’s covered by the Securities Investor Protection Corporation). Both FDIC and SIPC insurance have limits, but they’re crucial in safeguarding my deposits.
With those boxes ticked, I can choose from a couple of different products.
A high-yield savings account could be a good option for my emergency fund because of that high APY, though some “don’t allow ATM withdrawals or have checks and you would have to move that money back to checking to get it, which can take a few days,” says Jaspreet Chawla, senior vice president of savings products at Navy Federal Credit Union.
Another route could be opening a certificate of deposit, or CD. Depending on their maturity date, CD rates can offer even more impressive APYs than high-yield savings accounts. (At Marcus, for example, I can open a savings account with an APY of 4.15% or get a 12-month CD with an APY of 5.05%.)
But access can be a problem here, too, because with CDs, I’m agreeing to lock up a certain sum for a predetermined amount of time. And emergencies don’t exactly happen on a schedule.
“Be careful when it comes to choosing a certificate if you typically need immediate access to cash, because you can’t withdraw the money whenever you want,” Chawla says. “Usually, you must wait until a certificate’s maturity date to avoid an early withdrawal penalty.”
If liquidity concerns me — and it does — I could consider a money market fund, which is a relatively low-risk mutual fund, or a money market account, which is a type of savings account.
And I shouldn’t feel pressured to keep my entire emergency fund in one place, either. If I can score better perks or maximize my returns by splitting the sum into different accounts, that’s fine. It’s just personal preference.
The bottom line
My emergency fund isn’t doing me any favors by sitting in a regular ol’ savings account with a paltry interest rate. I should consider moving my rainy-day money to a place where it can grow, like a high-yield savings account.
“That’s what we always shop and search for [in an emergency fund]: yield, as well as security and safety from a liquidity perspective,” Patillo says.
