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’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!
I have always been a big fan of the FDIC-insured online savings accounts as a place to store your rainy day / emergency fund. I constantly keep an eye on the various online banks and the interest rates they pay. Since the Federal Reserve has been hiking rates a little bit for the past year or so, the rates on online savings accounts have gone up a little bit too. Right now, the highest online savings account rate I see is at DollarSavingsDirect, at 1.5%. Ally Bank has an 11-month no-penalty CD for 1.5%, with the one catch there being that you need a $25k minimum deposit to earn the 1.5%. Other reputable online savings accounts include Synchrony, CIT, Purepoint Savings, GS Bank, American Express, and Discover Bank -- just to name a handful. All of those are paying slightly less than 1.5% right now, though.
The difference between a CD and an online savings account is that a CD has a term during which the money is locked up. If you need to withdraw before the end of the term, there is a penalty. The aforementioned no-penalty Ally CD is a special offer where there is no penalty to terminate the CD before the term, so it functions more like a savings account with the penalty-free withdrawal feature. Unlike a CD, where the interest rate is fixed for the term, a savings account interest rate is variable and can change at any time, so you want to be vigilant to make sure that your bank is still paying you a competitive interest rate once your account is open there.
When you set up and fund an online savings account, you link the account to your main checking account and can transfer without penalty back and forth. This type of transfer is called electronic ACH (Automated Clearing House) and is free of charge. In an electronic ACH transfer, the money usually takes 2 business days to move between checking and online savings.
FDIC insurance protects you on up to $250,000 per depositor per financial institution, in the rare instance that the bank holding the money runs into financial distress. For folks who want to store more than $250,000 in cash, I recommend that they spread it out across banks to enjoy the maximum amount of protection from the Federal government. This protection would have been very helpful during the financial crisis in 2008. In such a scenario, you know the Federal government stands behind your deposits even if many banks are failing. Only go with a savings account that is FDIC-insured.
Hopefully that gets you pointed in the right direction!
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®
I do not suggest you invest your emergency money in anything with risk in it. Put it in the bank and leave it in cash. Just accept that its your 'sleep good at night' money.
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.