I just checked in on my $5,000 emergency fund and saw my monthly interest payment—a whopping $3.13. It’s not going to save me from financial ruin exactly, but as my grandfather would say, I guess it’s better than a stick in the eye.
Normally, as a financial planner, I would encourage you not to let a little number like that keep you up at night. Your emergency fund is the one place where it’s more important to preserve your cash (in case of an emergency, duh) rather than try to grow it. There are 401ks, Roth IRAs, and brokerage accounts for that.
However, there’s been a lot of buzz lately about “making money off your emergency fund,” so let’s explore this further.
What are your options, and what’s the risk associated with them?
High Yield Online Savings Account
The first is a high yield online savings account. I’ve always known the interest rate on my current account of 0.75 percent was good, but not necessarily the best out there. Like most people, I find the idea of switching banks an administrative hassle—it’s got to really be worth it.
Let’s say we’re all willing to move to an online bank that offers a higher rate of 1 percent interest. On an emergency fund of $5,000, this translates to $50 a year (an extra $12.50 more than what I earn now). Not bad, seeing as this amount is guaranteed as long as the bank’s interest rate offering stays put, and it’s even better if your cash currently sits at a more traditional, brick and mortar bank paying less than 0.05 percent interest. It’s worth noting, though, that a bank can change their rate at any time, so just because you see an enticing number at The Turbo-Interest Bank of the Interwebs, it might not always stay that way.
One potential downside of an online savings account – there’s usually no bank branch you can visit if you need help with account setup or a transaction. Also, if you decide to keep your account at your local bank, it may take a few days to transfer funds. However, many online banks now offer checking accounts as well for ease of use. If it sounds like an online bank could be for you, consider Ally or Synchrony bank.
Look into Certificate of Deposits
You could consider a CD, short for Certificate of Deposit. A CD is a product offered by banks and credit unions that comes along with a fixed interest rate and it is assumed that your cash will stay put for a set amount of time. After a quick search online, I found one of the highest one-year CD rates available was 1.29 percent. For example, if I purchased a $5,000 CD at that rate of 1.29 percent, it would only offer me an extra $14.50 over the high yield online savings account. And, if I needed that cash before the one-year lockup period is up, there is an early withdrawal penalty (usually equal to a few months’ interest). Is an extra $14.50 a year enough to compensate taking on that risk?
High Yield online savings accounts and CDs are conservative options for an emergency fund since you won’t risk losing your initial principal, but the interest earnings aren’t exactly life changing, either.
What if you want a better return? This brings us to investment options. Investing your emergency fund comes with a greater potential for earnings, but there’s a tradeoff: more risk.
The biggest risk of investing is not necessarily that the value of your investment will go up and down. (That’s a given.) Rather, the biggest risk is needing your money at the wrong time. For anyone who has ever tapped their emergency fund, you know you don’t get to choose when “the right time” is. If the market is in a downturn and your $5,000 investment is currently only worth $4,500, you likely won’t be able to wait for it to recover before needing to withdraw the funds.
If you’re willing to take on some risk with your emergency fund, what are some investment options that might make sense? An example would include short-term bond funds from providers, which may present an opportunity to earn more than cash without taking on the same level of risk as investing in stocks.
Do What’s Right For You
Deciding what to do with your emergency fund simply boils down to risk and the tradeoffs that come with it. It’s not so easy to say how much risk you can or are willing to tolerate—that’s a personal decision based on your financial situation and your risk tolerance should the market go sideways. As you evaluate these options, consider what kind of potential upside you would require in order to take on some risk. There’s no certainty the risk will become a reality—or that you’ll reach the level of upside you’re hoping for, either.
It’s also important to note this is not an all-or-nothing proposition. There’s no rule that says you can’t mix and match any of the above options. Imagine this scenario: You get laid off, but have some cash in your checking account to cover this month’s necessities. You also keep $5,000 in your emergency savings account: $1,000 in cash and $4,000 invested. Your quick access to cash in your bank accounts may give you the cushion you need to avoid selling the invested portion of your emergency fund if the market is tanking. You may be able to wait a week, month, or longer before needing to pull from your investments and lessen your losses.
Remember, even though it may be enticing to make some money off your emergency fund that is not its primary purpose. Your first priority should always be to prepare yourself for the unexpected because life can take some pretty wild turns. If you’re still yearning to get more bang for your emergency bucks, find a balance between risk and reward you’re comfortable with and stay the course.
Before joining the Society of Grownups, Karen Carr completed a BS in Finance and obtained her CFP®. Carr worked as an advisor at a boutique, private wealth management firm. She came to Society of Grownups because of her passion for working with young professionals, who have their own unique opportunities and challenges. Carr believes financial planning doesn’t have to be intimidating, is not a one-size-fits-all approach and that there are many paths you can take to reach your goals.
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While we hope this information is useful, it’s only intended to provide general education. It’s not legal, tax, or investment advice, and may not apply or be useful to your specific financial situation. Society of Grownups and Haven Life do not recommend, and cannot guarantee any products or services noted above.