0
0
Knowing how to properly invest your emergency fund is an essential part of wealth building. Having money set aside can and will make life less stressful in the event something unfortunate happens. Things go wrong all the time! A freak accident like slipping on a banana peel, and ending up in the ER, could put a damper on your wallet… I’ve been there before believe me (I really haven’t, but that would be an awesome story lol).
All jokes aside, having an emergency fund is a MUST. Most financial experts recommend that you sock away around 3-6 months of living expenses for that ‘rainy day’.
Why Bank Savings Accounts May Not Be The Best
Most people believe the best way to stash their emergency fund is in savings account at a bank (well duh… Brandon?). Although this logic is not wrong, I’m here to give you a different perspective on why there may be better alternatives.
First, here are some reasons I disagree with just throwing your stash in just any ole bank savings account:
- Your emergency fund is most likely losing money to Inflation
- Lower interest rates offered by banks
- Your emergency fund may be TOO accessible
Your Emergency Fund Is Losing Money To Inflation
“Prices are changing all the time, but we don’t say there is inflation every time we see a price increase. Instead, we say there is inflation when the prices of many of the things we buy rise at the same time and then continue to rise. Explained another way, inflation is ongoing increases in the general price level for goods and services in an economy over time.”
Federal Reserve Bank of Cleveland
If you’re putting your emergency fund into a traditional bank savings account, inflation will eat away at its value. That’s because banks pay interest rates based on the rate of inflation. However, as inflation rises your interest rate is likely not to keep pace. This means that your emergency fund will lose its purchasing power every year.
You may not see the effects of inflation on your emergency fund in one year. But, throughout a couple of years, this can put a SERIOUS drag on your wealth! The annual Inflation rate is 2% on average. So, the further your money is from collecting 2% in interest, the more money you are losing.
According to the FDIC (Federal Deposit Insurance Corporation), the average interest rate for savings accounts is a stellar 0.10%!! Yes, that is indeed AWFUL!!! At this rate, you would be losing 1.90% value in your purchasing power annually with normal inflation!!!
At the time of this post being written, there is nothing normal about inflation right now. The annual inflation rate as of July 2022 was 8.5%, based on data from the BLS (Bureau of Labor Statistics). This inflation rate is just a reflection of the times. Unfortunately, there is no safe investment that would yield an interest rate anywhere near that… Yeah, that inflation rate made my stomach turn too.
Lower Interest Rates Offered By Banks
In contrast, there are investment accounts with a high yield (or return) that can offer higher returns than a regular savings account. Accounts such as money market funds, CDs, or even online savings accounts typically offer higher yields. Some may also have lower minimum balances required to open them.
Since there are soooo many places for you to put these funds, and collect a higher interest rate. Why on earth should we limit ourselves to one bank? I will dive into said places later in the post, but if you haven’t been convinced to look outside of your bank already… LOOK!
You’re a customer in the bank’s eyes… Wanna know how I know? I WORK AT ONE!
What do customers do when they are looking for the best deal? THEY SHOP!
So, how are you going to shop in this situation? EASY, you’re going to shop around for the highest interest rate you can find!
Your Emergency Fund May Be TOO Accessible
If you’re putting your emergency fund into a bank savings account, then you might as well put it in a checking account too. This means that you’ll have access to it 24/7, so there’s no need to worry about losing track of it. However, if you do decide to invest your emergency fund, make sure you choose a low-risk option.
We all know that not everyone has the restraint to fight the temptation of dipping into their emergency fund. Every so often there is that costly item of interest that can draw your attention. Whether that costly item is a ticket to the Cayman Islands, a Gucci bag, or the latest pair of Yeezy’s, I’m certain that your EMERGENCY FUND wasn’t intended for this!
There are plenty of banks/investment institutions out there for your money to sit with. I would say the phrase ‘out of sight, out of mind’ could be the best solution to this problem.
Where Can You Invest Your Emergency Fund?
There are plenty of ways to invest in your emergency fund, but I want to hammer the message that the investment needs to be a low-risk option. You should avoid stocks, bonds, and other investments that fluctuate wildly in value.
Your emergency fund is your safety net when your finances are getting dicey. So, it wouldn’t make sense to risk your safety net, right???
Let’s look at a few alternative ways to invest your emergency fund:
- Certificate of Deposit
- Online High-Yield Savings
- Money Market Funds
Certificate of Deposit
A certificate of deposit (CD) is an investment vehicle that lets you borrow against the value of your money. You make regular deposits into the CD, and when you withdraw the funds, you pay back the principal plus interest. Certificates of deposit are offered by banks and credit unions.
CDs are typically guaranteed by the FDIC up to $250,000. FDIC insurance is important because it protects if the bank were to go bankrupt. Your money repaid to you by the federal government in the event this happened.
Although these investment vehicles may pay more interest than regular savings account they are typically purchased in terms. Before purchasing a CD for any term make sure you won’t need the money during that time. There are typically penalties involved when withdrawing the funds prematurely, which can reduce the amount of potential interest you could collect.
Terms can vary from three-month, six-month, nine-month, or one- to five-year CDs. The links provided are sourced from Investopedia and compile some of the best CD options currently available. At the time of this writing, the highest interest rate for the one-year is 3.10%. That is pretty good if you ask me!
Online High Yield Savings
Online savings accounts allow you to set up a regular payment schedule so you can automatically transfer funds from your checking account to your savings account. These accounts usually offer higher interest rates than traditional savings accounts as well.
These accounts are great since you can access them whenever you need to. They operate just like the regular savings account at any bank, but have higher interest rates and lower fees. Online banks are typically able to shave some of the cost on their end by not operating out of a physical building.
You should rest assured the FDIC typically insurers up to $250,000 per depositor for these banks as well. So no need to worry if the bank were to suddenly collapse. Although, the odds of this happening are slim since the FDIC usually monitors bank performance over time!
These are also great accounts for the ‘out of sight, out of mind’ mentality! Online banks offer their apps and sites to access your account, so you won’t see these funds every time you log into your normal bank account. You can set up automatic transfers to it and pay bills from it as well if you would like.
At the time of this post, interest rates are as high as 2.10% for these accounts, with no minimum terms to lock up your money. See this link that comprises some of the best paying online savings accounts from Nerd Wallet.
Money Market Funds
Money market funds are essentially mutual funds that invest in short-term low-risk debt. They are the lowest volatility when it comes to investment in the financial markets. These funds are liquid (meaning you can get in and out of them whenever you like) and have interest rates adjust depending on the market. The interest offered by these funds is usually far greater than any traditional bank savings as well.
A downside is that the FDIC does not back money market funds, since they are investment vehicles. But the US government does guarantee some of the securities that money markets invest in! That’s right, a nation that has never defaulted on a debt.
Brokerages such as Charles Schwab, Vanguard, or Fidelity offer money market funds. This is my favorite way to invest my emergency fund since I like to keep all of my investments with my brokerage. A simple way to benefit from some of the best interest rates available without moving a finger!
In Conclusion
A bank savings account isn’t necessarily the wrong place to be to save money, but if you don’t plan to touch that money for a while, let the money work for you. The major key to wealth building is making your money grow! As you can hopefully see now there are many ways to continue growing your money without it sitting on the sidelines completely!! Be the customer you are and shop!!!
DISCLAIMER: The above references an opinion and is for informational purposes only. It is not intended to be investment advice. Seek a duly licensed professional for investment advice. Do your research, this content is intended to be used and must be used for informational purposes. It is important to do your analysis before making any investment based on your circumstances.
I found the information in this article very insightful and well-written. Investments are tricky at best, but using the technics listed will place even the novice in a better frame of mind when contemplating saving for a rainy day. Thanks so much for the valuable information.