One of my financial goals for the year is to figure out what to do with my emergency fund.
I'm tired of watching my cash earn next to nothing in traditional savings account at my bank. I was determined to eek out as much interest from that cash stash as possible.
There are a lot of options out there for parking your money. Sadly in our current low-interest-rate environment, there aren't many appealing options.
Even though my stash is relatively modest at $25,000 I still feel it should earn its keep.
Why is an Emergency Fund Important?
The purpose of an emergency fund is to cover your needs in case some kind of unexpected event occurs. This could be a temporary loss of work, a very large expense, or some other type of unforeseen need.
The general guideline for an emergency fund is 6 months' worth of expenses. But in all honesty, what you decide to park in an emergency fund will depend heavily on your personal circumstances.
If you have high debt, live paycheck to paycheck, have an unstable working situation, or other personal circumstances, you may need more. Alternatively, if you have high cash flow, are comfortably retired, and have low-risk exposure you may need less, or perhaps even none.
The relative importance of an emergency fund will vary from household to household.
How Much Emergency Cash Should I Have?
It's critical to evaluate the financial health of your household before deciding what size emergency fund you need.
For our household, it's really just a matter of preference as opposed to need.
Our total expenses for the year average about $50,000. In reality, only about 50% of those expenses are absolutely necessary. By setting aside a $25,000 emergency fund, we have the ability to access 6 months' worth of total expenses or a years' worth of fixed expenses.
Depending on the situation that should be plenty of cash to overcome a short term emergency.
We also have some fairly large credit lines on the few credit cards we own, which can be used as a last resort back-up for short term cash flow. Note that in the 20+ years I've owned credit cards, I have yet to pay any of them a single cent in interest. This is not a recommended fall back plan if you can't pay off a credit card in full every month.
Available Options for an Emergency Fund
Once I settled on the amount I wanted to park, I came up with a shortlist of criteria and started scouring the internet for available options.
Here's what I used to narrow down my search:
- An interest rate that will buy me a sandwich
- Very little risk
- A process that takes less than 5 minutes to complete
- The ability to easily move funds between my main bank account and the new one
- Easily accessible with low to no withdrawal penalties
Based on the above criteria, I narrowed down my options to two viable paths.
My initial inclination was to go with one of the online savings accounts that are popular with many people. Their rates are all fairly similar and currently range from 1.0-1.5% interest.
During my search, I also discovered that many of these same banks offer short term high yield CDs. The interest rates vary based on terms, but most were higher than a simple online savings account, ranging from 1.2-2.0%.
These rates may not seem like much, but when you're earning 0.01-0.02% on your money at a standard savings account, a 100-x increase will get your attention!
Why I decided on a CD over an Online Savings Account
After evaluating my own personal circumstances, I realized that the only advantage an Online Savings account has is immediate, penalty-free access to my stash.
Since we're in a dual household income, and our expenses are fairly low, the odds of needing to access that cash immediately is fairly low. And with the penalties of early withdrawal on a CD being fairly limited (depends on the bank), the financial impact is muted.
I saw no reason to forego the higher yield on a CD compared to an Online Savings account for our situation. Granted the difference is not that significant.
I ended up opening an account with Ally Bank which ticked off most of my criteria. Here's a snapshot of their available CD rates as of publishing this post, filtered for the periods I was interested in.
I ended up locking in a 2.00% annual rate for a 12-Month High-Yield CD. I got lucky when I signed-up because they dropped the rate just a couple of days later.
By sticking to a 12-month, it gives me the opportunity to re-evaluate my situation each year, and adjust as necessary.
It also gives my emergency stash the optimal chance to grow based on my limitations. At that rate, the fund will generate $500 in interest. Which is better than the $5 it was earning before.
If for some reason I had to access the funds prematurely, Ally Bank charges a penalty of 60 days interest. This works out to $83 which I feel is negligible.
An emergency fund like this becomes more important once I reach financial freedom, especially if both Mrs. Max and I stop working steady jobs. At that time, we'll have to re-evaluate our situation and make adjustments as necessary.
In the meantime, having a fund like this will force me to focus on my remaining cash and finding ways to make that money more productive. My goal will be to end each year with a zero balance in my traditional savings account since any money generated throughout the year will need to find a home.