An emergency fund is a critical part of a healthy financial plan. It helps you handle life’s curveballs without taking on debt or falling behind on existing bills. But the question that often comes up is where a good place to put an emergency fund is.
I’ll say it here, that the best place to put your emergency fund is in a high-yield savings account. Let that cash earn some interest, but keep it accessible if there is an emergency.
Okay, now that’s taken care of. But let’s talk about places to NOT put an emergency fund. I have seven specific places to avoid, along with a detailed explanation on my reasoning.
1. Mutual Funds, Index Funds, ETFs, & Stocks
When your money is in an investment account, it is subject to the fluctuations of the market. The market tends to go up over time. But sometimes, there are recessions, pandemics, and bank failures.
These events can cause the value of your money to go down for a period of time. Odds are, it’s in those types of times that you’ll need to have cash available.
In a recession, you may experience a job layoff. If that happens, having your emergency fund’s value preserved is critical. But if the market is down, the available cash you could get out may have dropped significantly.
On the other hand, even if the market is up, withdrawing from an investment account is not without consequence. There may be short-term or long-term capital gains taxes on the balance in your account. In the middle of an emergency, that’s not an additional variable we want to add to the decision-making process.
Bottom line: investments are for long-term wealth-building, not to insure against life’s emergencies.
2. Certificates of Deposit
A certificate of deposit offers interest on the cash you use to purchase it. Oftentimes these interest rates are higher than on high-yield savings accounts. For example, in March 2023, may CDs offer 5-6% interest.
In a time of uncertainty, that can be an attractive place to secure your money while also making some.
The big downside is that a CD locks your money away for the term of the CD. If you need cash for an emergency, having your emergency fund in a CD makes it much harder to get to.
Not only that, but if you cash it out early, there are often penalties assessed. In a time where an emergency is needed, having a portion of it forfeited to the bank or credit union is an unnecessary loss.
Bonds are also a way of preserving the cash value while also earning some interest. Certain bonds, like I-bonds, have actually had very high yields recently. Last year, I-bonds went to over 9% APY because of the inflation spike. (The I-bond interest rate is tied to the inflation rate).
Unlike securities like stocks, mutual funds, and index funds, bonds are debt instruments. The issuer of the bond borrows the money from you as the buyer of it, and then pays interest on it over time until it matures.
But just like with Certificates of Deposit, this locks up your money until the maturity date. If you cash in the bond early, you may take significant losses and have penalties to pay. Not to mention there may also be tax consequences.
Keep in mind as well that as interest rates rise, the value of a previously issued bond goes down. That means a loss of your emergency savings when it may be most needed.
Cryptoassets are a fairly new player in the financial world, and many people are skeptical of them. It’s understandable, but these currencies are not going anywhere. They will only become more popular over time, and more merchants will begin to accept them as payment.
The biggest issue with cryptocurrency is that it is highly volatile right now. Emergency funds need to be stable and available. If your emergency fund is in something like Bitcoin, Ethereum, Polygon, etc., there is a significant change the value of your money could drastically shoot up or down in a short period.
And just like with investment securities and bonds, if you sell off the cryptocurrency there may be tax consequences. The IRS treats cryptocurrency as property and not as foreign currency. That means short-term or long-term capital gains tax on any growth.
Though crypto isn’t going anywhere, putting your emergency fund into this is incredibly risky.
5. Accounts That Pay Little or No Interest
As I mentioned above, my recommended place to park an emergency fund is in a high-yield savings account. The flip-side of this is that a savings account with little or no interest is a place to not place it.
In the United States, we have what’s called a fractional reserve banking system. Banks take our deposits and place them in their institutions. The bank then technically owes us, the depositor a debt, in the amount of our deposit.
The bank uses these deposits (checking, savings, and all other deposit accounts) to issue loans and purchase the bank’s own investments. In essence, we are allowing the bank to use our money so the bank can make money.
If they’re paying pennies in interest for the privilege of you depositing your money there, take it elsewhere! You don’t deserve to be insulted like that.
The mega banks are the worst offenders with this. Bank of America, Chase, Wells Fargo, etc. have abysmal interest rates. We’re talking .01% a lot of times (yes, one one-hundredth of a percent).
Instead, look for a bank or credit that won’t insult you and will actually pay something decent for the privilege of holding your emergency fund. For example, banks like Ally and Capital One offer around 3.6% APY on your savings.
Is it life-changing? Not really. But if someone wants to give me a check for a few hundred dollars or more just for parking my emergency fund there, I’ll take it!
6. Safe Deposit Boxes
Contrary to popular opinion, safe deposit boxes are not so safe any more. At one time, the idea of putting valuables in a safe deposit box was alluring. Have a place outside your house that few people know about and is heavily protected at all times.
Except now, the FBI believes that it can mislead federal judges and steal the contents of the boxes. Even when there is no evidence a box owner committed a crime, or that the property held in the box is connected to a crime in any way.
There is an ongoing lawsuit about this in California right now. And what is even more infuriating is that the courts don’t seem to think this is much of a problem. Fourth Amendment rights against unreasonable search and seizure be damned!
If this is the view law enforcement takes toward safe deposit boxes, and the courts sign off on it, avoid them. Place your emergency fund elsewhere. Heck, even in your own house is better, since police cannot cross the threshold of your home absent consent, a warrant, or exigent circumstances.
Avoid the not-so-safe deposit boxes! We may not like to think about police as the bad guys. But the line between good and bad is, unfortunately, becoming increasingly blurry.
7. Any Type of Debt Product
Lastly, anything that involves using debt is not an emergency fund. Credit cards, personal lines, lines of credit, etc. These are products that put us under someone else’s thumb, and has us giving them passive income in the form of interest.
Let me emphasize it. Using a credit card for emergencies and then paying it off over months and months is not an emergency fund. This is adding more risk to your financial situation.
And odds are, it’s at a time when it is quite inconvenient to add in new monthly payments.
Closing Thoughts on Where to Put an Emergency Fund
An emergency fund should be reasonably accessible and in liquid cash. A high-yield savings account is the best place to park it. These other vehicles we discussed are not good places for your emergency savings.
Each has its own purpose, but holding your emergency fund is not one of them.
I recommend having an emergency fund of 3-6 months of expenses when you have paid off all consumer debt. While in consumer debt, have a starter emergency fund of at least $1,000, but no more than $2,500.
To get your emergency savings goals going, along with your other financial goals, book your free Discovery Session with me now!