How should I invest my emergency fund so that I keep earning interest on it?
I have established a solid emergency fund. I know that it needs to remain liquid, but I still want to earn interest on the amount. Where do you suggest I invest the money?
You can open a brokerage account at a discount brokerage firm like Schwab and then invest in a laddered short term CD portfolio. So if the emergency fund is $45k, then invest $15k in a 1 month CD, another $15k in either 2 or 3 month CDs depending upon the interest rate offered, and then a final $15k in 6 month CDs and keep rotating. This will maximize your interest.
Here's one hint though, the brokerage firms get their new inventory of FDIC insured CDs usually either Monday midday or Tuesday morning and that is when you will get the most offerings and best rates. Again, depending upon what the rates are would depend upon the ladder. I just recently purchased some CDs at Schwab for a client and I found a 2 month CD just as high as the 3 month CDs, so there was no reason to go out 3 months.
This is still not much, 1% to 1.5% currently, but much better than a money market, and a short term bond fund can flucuate. Now if you sell before maturity it is a bid-ask quote so you might have a very marginal loss, but if you hold to maturity, there would be no loss and it is FDIC insured. So this could also affect how you create the ladder for highest interest and adequate liquidity. Unfortunately, with the Central Banks manipulating interest rates down to almost zero, there are not many alternatives that are 100% liquid and pay anything worth while. This will remain until rates "normalize."
Hope this helps and best of luck, Dan Stewart CFA®
Keeping three to six months of living expenses at a minimum as an emergency fund is recommended. Unfortunately, with the current interest rate environment we are in, limits the potential short term/fixed income investor. There are not many choices to choose from.
Additionally, you need to be aware of any transactions costs that short term investments may incur, in order to calculate your total return.
There are some online money market rates advertised. Make certain to read the fine print.
Congrats for establishing an emergency fund, it is an important part of your overall financial health. We are currently in a low-interest environment, so there are not a lot of options for earning interest on the account while still keeping it safe and accessible. Your safest and most liquid alternative would be in a money market account. Some on-line banks are currently offering interest rates in the 1.2 to 1.5 percent range, which while not great, are much higher than a standard savings account. If you are on the high end of the emergency fund amount and are willing to lose some accessibility and or take on additional risk, you could use CDs and or invest a portion in a bond fund. CD's give you the same security as the MM account for slightly higher interest rates, but the money can only be accessed without penalty when CDs mature. With bond funds, you have access to potentially higher returns, but those higher returns bring the risk of losing some of your principal, and are slightly less liquid than a Money Market account. The right answer for you will be dependent on your situation and may involve one, two, or even all three of these options.
You’re correct in keeping your emergency fund liquid, meaning not invest the money, which is hard to do at the present environment. Seems everyday the market hits a new record high, and here you must earn a paltry yield in order to access to the emergency fund without losing principal or being penalized by an early withdrawal. Thus, a better way to handle your emergency fund is to develop a CD-ladder. Invest your money in a 3-month, 6-month, 9-month, and 12-month CD. As you can see, one of your CDs matures every 3 months, and hopefully it will lock into the next higher rate. Yet, at the same time, you have the flexibly to access to the account in case of contingency. Best!
You want to make sure that you keep your emergency funds safe and available. Sometimes you can get a better interest rate with online or local banks, but they will rarely give you interest that will keep up with inflation. You can ladder CD's, but that won't give you much more interest. Short-term bond funds have been great for the past 2 decades, but if interest rates rise then you could see them drop in value.
I actually wrote an on safe money alternatives with insurance products, but I would only recommend that if you're over 59 1/2 since you want access to the money without a tax penalty.