How to Put Your Emergency Fund to Work

Doc's note: Last week, my team and I shared one of the most critical parts of being healthy… movement. We walked you through three ways to get up and moving – from beginner to expert level.

This week, we're focusing on how to take control of your wealth in the new year. Today, we're starting with the most basic ways to do this. If you want peace of mind when it comes to your wealth, you need to have an emergency fund. If your car breaks down, you lose your job, or you have an urgent medical bill insurance won't cover, an emergency fund helps you get through some of your worst moments.

Today, we'll share why an emergency fund is essential and the best places to keep your cash…

Today, I (Laura Bente) want to get back to the basics...

We've talked before about the importance of paying off debt, investing in your retirement, and cultivating your financial literacy.

But before you do any of that, you need to make sure you've saved for emergencies.

I learned this myself a few years ago when a storm tore the siding off my house, and I knew I would need to cover my homeowner's insurance deductible.

Fortunately, I had an emergency fund to lean on for exactly these kinds of unexpected bills, so I didn't need to put these expenses on a credit card or borrow against my home's equity.

But most Americans aren't so lucky...

Earlier this year, 56% of Americans reported only having $1,000 or less in savings. And the pandemic and continuing inflation have put more of a strain on our bank accounts than we've seen since the Great Recession.

If you look at your financial life as a house, an emergency fund should be the foundation. You want to make sure that, in the event of an accident or job loss, you have the funds available to pay your expenses.

Typically, financial planners recommend having about three to six months' worth of take-home pay in your emergency fund. We've even seen some recommendations for as much as nine months' worth of pay saved.

How much you need to keep depends on factors like your marital status, if you have kids, your health, and your job stability.

If you're a longtime Health & Wealth Bulletin reader, you've heard all of this before.

But a friend asked me a question I hadn't heard before...

Where should I keep my emergency fund?

He explained he was finally working on saving up his emergency fund and wondered if he should just keep it in a checking account...

That's probably one of the worst things you can do with it.

Most checking accounts don't pay interest. And those that do often require balances of $1,000 or more just to earn 0.01%, annually.

You don't want to risk your emergency fund, but why not make it work for you?

Savings accounts are one of the easiest and safest places to keep emergency money. Savings accounts are FDIC-insured, which means that the Federal Deposit Insurance Corporation will make depositors whole – up to $250,000 – should the bank make bad loans or experience financial disaster.

Most savings accounts require a small minimum deposit to open, anywhere from $1 to $100. Banks have various types of savings accounts, including accounts specifically created for kids. And some banks offer higher interest rates the more money you keep in the account. But you don't earn much... Right now, the national average interest rate is 0.05%.

A money-market account ("MMA"), sometimes called a money-market deposit account, will usually have higher minimum deposit requirements. This can be as low as $500 or as high as $1,000, and they often pay a higher interest rate. With a current national average of 0.41%, an MMA offers significantly more interest than you'd make in a savings account.

Something to be aware of... Both savings accounts and MMAs limit your monthly transfers to six.

Certificates of deposit, or CDs, have many of the benefits of savings and money market accounts... They pay interest and they're FDIC-insured. But when you put your cash in a CD, you agree to leave it there for a particular amount of time – usually between three months to five years – and you'll pay a penalty for early withdrawal.

Since the money is locked up, the bank will give you a higher interest rate. Right now, the national average is 1.77% on a one-year CD. Although the interest rate is higher, CDs aren't a great emergency fund because of the withdrawal penalties.

Of course, the easiest way to access cash for an emergency fund is through a savings account. Big national banks, like Bank of America and Wells Fargo, offer basic savings accounts that yield 0.01%.

But there's an even better type of savings account…

A high-yield savings account is often your best bet for a higher interest rate without the limitations of a certificate of deposit or a money-market account. Right now, banks are offering anywhere from 3.8% to 5% for high-yield savings accounts. Many banks don't even require a minimum balance.

Once you know the type of account you want, you'll want the best rate. Websites like Bankrate and NerdWallet can help you find the best rates.

If you want to skip the big banks altogether, join a credit union. Credit unions are nonprofit companies that act as local community banks. Credit unions often pay the best rates, but many have membership requirements. Sometimes it's as easy as living in the community that the credit union serves, but it can vary. You can find a credit union near you with A Smarter Choice.

(Note: We do not endorse nor are we affiliated with any credit union or financial institution mentioned in this letter or in the links above.)

Here's to our health, wealth, and a great retirement,

Laura Bente, CFP®
December 30, 2024