Where to keep your 2021 emergency fund
The most important thing is to just have an emergency fund, but you also need to know where to put it.
If you’ve set yourself a goal of building your emergency fund in 2021, you’re not alone. Due to the COVID-19 pandemic, many people are using it this year to replenish depleted emergency funds or to add more money for a bigger financial cushion.
Since this is money for emergencies, where you keep it is crucial. It should be easily accessible at all times. It’s also good if you can earn interest on the money in your emergency fund, but you don’t want to put it where the value could drop.
Read on for the types of accounts you can store your 2021 emergency fund on, starting with the top choice.
The best option: a high yield savings account
High yield savings accounts are great for emergency funds. They have some of the highest interest rates you can find without restrictions on when you can access your money or whether you can lose it.
When you have a high yield savings account, you can withdraw and deposit money at any time. Many of these accounts also don’t have monthly fees or minimum balance requirements. If you’ve just started your emergency fund, you won’t have to worry about not having enough to deposit.
For the typical consumer, the best place for an emergency fund is in a savings account. This is the type of account I use for my emergency fund and recommend to anyone who requests it. Next, let’s go over some alternatives.
Money market accounts
Money market accounts are not as widely used as checking and savings accounts, but they have both advantages. Their interest rates are often comparable to those of high yield savings accounts. Plus, you can access your money anytime, and like checking accounts, money market accounts offer debit cards, checks, or both.
While a money market account can be a good place for an emergency fund, some have minimum balance requirements that you must meet to avoid monthly fees or earn a higher interest rate. It is best to avoid accounts with these types of minimum balance requirements for your emergency fund. Your balance may drop below this minimum if you need to use some or all of the money.
Certificates of deposit
With certificates of deposit (CDs), you deposit your money for a fixed period of time. The terms generally range from six months to five years. CDs tend to have higher interest rates than savings accounts, so you can earn a little more of a return on your money. You also lock in the interest rate when you receive the CD. It’s good if interest rates go down, but not if they go up.
The problem with using CDs for an emergency fund is that they have early withdrawal penalties. Withdraw your money before the end of the term and it will likely cost you several months of interest. You also cannot add more money to a CD after opening it.
A CD isn’t a bad place for your emergency fund, assuming you’re prepared to incur an early withdrawal penalty if necessary. But savings accounts and money market accounts are both much more flexible options.
What to avoid: investment accounts
You might be tempted to invest your emergency fund. On average, the stock market offers a much higher annual return than savings accounts, money market accounts, and CDs. With one of the best online stock brokers, you can easily get a diversified portfolio by investing in index funds or mutual funds.
But with the potential profit comes a higher risk, and that is why investing is one of the most common mistakes of emergency funds. Although the stock market offers high annual returns on average, there are also bear markets where values fall. And these times often coincide with economic downturns, when you may need your emergency fund the most.
When it comes to your emergency fund, the smartest option is to keep it simple. A high yield savings account will give you the most flexibility and a reasonable interest rate. Money market accounts also work well, and some consumers like to use CDs to earn more interest. Anywhere else, including investment accounts, is not recommended.