A financial advisor says there are 4 smart ways to grow your emergency fund - here's how they stack up
- Financial experts recommend having an emergency fund that's equal to three to six months worth of expenses.
- The best place to store your emergency fund is in a high-interest account that's safe and liquid.
- Financial advisor Ric Edelman says there are four options: savings, checking, or money-market accounts, and money-market funds.
- You can't go wrong with any of them, but they do have some different features to consider.
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Whether you call it a rainy day fund, an emergency fund, or an "oh sh--t" fund, there's a better place to keep it than your sock drawer.
Most financial experts recommend building up a cash fund equal to three to six months of expenses to draw on in case you run into an unforeseen financial burden, such as temporary unemployment or costly medical bills.
But just because you may need the money in a pinch doesn't mean it should sit around collecting dust. If you put it in the right type of account, you can still access it quickly but it can also earn interest. While you won't wreck your financial life by not storing your emergency fund in a high-interest account, your money will almost certainly lose value thanks to inflation.
According to Ric Edelman, a financial advisor and the cofounder of Edelman Financial Engines, you should "choose an account that keeps the money safe from loss, meaning the value won't fall due to declines in the financial markets, and liquid, meaning you can access your money at any time with no fee or restrictions."
That leaves you with four options, he said: savings, checking, or money-market accounts, and money-market funds.
Here's what you need to know about each:
1. Checking accounts
This is your run-of-the mill bank account. Checking accounts are the most liquid option of the bunch, meaning your cash can be accessed at any time through a debit card, cash withdrawals, and checks.
These types of accounts earn paltry interest, though - usually below 0.1%, so they're often not the best place for making the most of your money.
Not to mention the fact that keeping savings that's earmarked for an emergency combined with your everyday cash could get confusing.
2. Savings accounts
There are traditional savings accounts and high-yield savings accounts. The high-yield accounts offer - you guessed it - higher interest rates. Depending on the bank, a bigger balance can yield a higher interest rate (up to a certain point).
Online savings accounts, as opposed to big bank branches, usually offer the best rates, which can be up to 200 times more than a checking account.
3. Money-market accounts
Money-market accounts are very similar to high-yield savings accounts - the only real difference is how you access them. Some money-market accounts come with debit card and check-writing capabilities, but you're still limited to six withdrawals or transfers per month.
Money-market accounts also may require minimum balances of $2,500 to $10,000 or more to earn the highest interest rate available, while you can open a high-yield account with as little as $1. If the balance falls below the minimum, you'll incur a fee.
4. Money-market funds
Money-market mutual funds are a type of low-risk investment, not a checking or savings account. While it is considered one of the most liquid investments because an account holder can typically access their money within a day, there's still a chance of losing money on the initial investment.
"It is best to choose one that invests solely in US Treasury bills, as this is the safest," Edelman said. High safety may equal a lower interest rate, he said, but the point of an emergency fund in particular is to keep the money as safe as possible, not to earn the highest possible return.
"Consider someone who wants to save $10,000," Edelman said. "An extra 1% is $100. After taxes, it's only perhaps $70. Is it worth risking $10,000 to get an extra 70 bucks?"
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