Transcript:

An emergency fund should be in highly liquid and safe accounts. These accounts allow you to transfer money on demand without the fear of losing it due to market fluctuations. It is hard to appreciate that flexibility when interest rates are low and the stock market is heading for new highs. Still, you will thank yourself when the inevitable decline in the economic cycle puts stress on the economy. Consider any forgone growth on this money as your insurance premium to ensure the money is there when you need it. Here are the typical places people put their money:

Regular bank savings accounts are likely the safest and most accessible if you bank locally. If you value the flexibility of walking into a branch and accessing cash, you may want to consider leaving one month’s worth of expenses at your local bank and put the rest in a different account. These accounts offer FDIC insurance.

High-yield savings accounts are typically available from online banks and offer significantly higher interest rates without a branch’s convenience. If you are comfortable banking online and don’t foresee needing emergency cash the same day, this can be an excellent option for your three- or six-month emergency fund. These accounts offer FDIC insurance as well. 

Money market mutual funds are offered by every major brokerage firm. They are a highly liquid mutual fund usually invested by short-term U.S. Treasury or agency debt securities, and strive to maintain a $1/share price without fluctuations. Depending on the interest rate environment, these accounts may provide better or worse interest rates than a high-yield savings account. Money market mutual funds tend to be a popular option with retirees because check-writing is common and makes money accessible without a bank transfer. These accounts are not FDIC insured, so always check with your brokerage firm to see what protection those funds will have.

Short-term bond mutual funds are a possible option for retirees with large emergency funds. You can allocate a portion to obtain a higher yield. Beware that these funds do experience fluctuations, and you may be risking the principal. Like money market mutual funds, these accounts are also not FDIC insured, so always check with your brokerage firm to see what protection those funds will have.

Let’s see an example of how our fictional clients John and Mary Jones, put away their $48,000 emergency fund (a year’s worth of expenses):

John is very conservative and likes being able to access cash. He knows that they have more than enough assets and income that they will likely be able to cover most emergencies, but it gives him peace of mind to have one month’s worth of expenses ($4,000) at his local credit union savings account.

Mary wants their money to work more for them and does not like the credit union’s interest rates. Hence, she and John agree that they can put five months’ worth of expenses ($20,000) in a high-yield savings account from an online bank that offers 10x the interest vs. their local credit union. Their brokerage money market yields are lower than the high-yield savings. 

John & Mary would rather not keep more than six months in cash, so they decided to put their remaining six months of their emergency fund ($24,000) in a short-term treasury bond mutual fund.

This illustration shows that you can pursue a single account or spread your emergency fund across multiple accounts to fund your needs. In the end, the type of account is less important than having one (so long as it’s safe). An emergency fund can give you the peace of mind you need to handle the surprises coming your way and keep your eye away from market volatility. Remember, emergencies will come; we just don’t know how they will manifest themselves.