Aside from your checking account, is there a good place to put your emergency cash so that it won’t be eaten up by rising inflation? Unfortunately, with interest rates being so low, the pickings are slim, but you do have a few options: money market accounts, high-yield savings accounts, and CDs. Here’s a look at how they work.
First off, why is an emergency fund important?
Financial advisors typically recommend keeping a cash fund worth at least 3-6 months of your expenses for emergencies. The reasoning for this is that unlike long-term investments, such as index funds or bonds, you’ll want cash that is easy to access — or “liquid” — if you suddenly need it. And since it’s just sitting there, you might as well maximise the interest that will accrue on your balance. But where to start?
High-yield savings account
Most people are familiar with savings accounts, which are similar to a regular checking account that you use for debit charges, except that it has more restrictions on withdrawals (“high-yield” is a designation that merely describes accounts that offer the best interest rates).
Typically, the number of withdrawals you can make from your savings account is limited to six each month. Going over that limit can result in a fee, which is why savings accounts aren’t used for daily transactions. Currently, high-yield accounts offer a percentage yield (APY) of around 0.50-0.60%.
Money market account
A money market account is sort of a checking/savings hybrid. Like a checking account, it comes with checks and a debit card, but it also has a limited number of transactions each month, like a savings account. These accounts can offer APYs closer to 0.60%, which is comparable to a high-yield savings account. The trade-off is that there can be transaction fees, and a larger deposit is often required to open the account, usually somewhere closer to $US2,500 ($3,420).
Certificates of Deposit (CDs)
A CD is a tricky option because they offer the best interest rates compared to money market accounts and savings accounts, but they’re less liquid, as you’re committing to locking away your money for anywhere from few months to five years, depending on what you choose (and there are fees for early withdrawal). You can find rates of 0.70% APY for one year terms, and up to 1% APY for two year terms.
This option might not work well for your emergency fund, but they can be a good way to squirrel away cash for other purposes, like a trip or some other big purchase you’re planning for in a year’s time.
Unfortunately, with interest rates so low, there’s only so much you can do to mitigate the effects of inflation. That’s why many people try to minimise how much cash they have lying around, usually by ploughing that into long-term investments like index funds.
But for the cash you do keep, you might as well maximise your interest rate. Depending on the size of your deposit, what the cash is meant for, and whether you need some flexibility to spend it, any one of these types of short-term savings accounts can be a good option for you. Sure, a half percentage difference on thousands of dollars will likely result in $US50 ($68) or less in accrued interest in a given year, but why not take what you can get?