Conventional wisdom calls for keeping enough money in a rainy day fund to cover three to six months of running expenses as well as all insurance deductibles. But sequestering tens of thousands of dollars in a savings account that earns a miserable 0.01% is painful.
There are better ways – like the following four alternatives – for an emergency fund to earn more.
These FDIC insured accounts at a bank or financial institution offer slightly higher annual returns, currently 0.35% to 0.56%, than savings accounts. Additionally, an amended federal regulation lifted the six-per-month restriction on check writing and ATM withdrawals, but check with your bank first.
Certificates of deposit offer higher returns because you lock in your money for a fixed period of time, from a few months to several years. If you use the funds earlier, you pay a penalty, usually a certain number of months of interest depending on the term of the CD. The current annual returns for a one year term range from 0.50% to 0.70%.
You can earn more without tying up all your money by building a CD ladder with staggered maturities. “That way you know there is always money available,” says Zaneilia Harris, certified financial planner in Upper Marlboro, Maryland, and author of Finance and stilettos. For example, you can create a ladder by investing $ 5,000 each in a six-month, one-year, 18-month, and two-year CD. Every six months, one of the CDs matures, releasing $ 5,000. If you don’t need the money, reinvest it into the ladder.
A money market fund of a mutual fund company invests in cash and short-term debt securities, such as treasury bills. These low risk funds can be cashed out easily, although they are not FDIC insured.
Like a money market fund, a short term bond fund offers higher returns in exchange for slightly higher risk. These funds invest in treasury bonds, municipal securities and shorter-maturity corporate debt. Since the price of funds tends to stay fairly stable, you can usually sell stocks in an emergency without risking big losses.
Ted Halpern, president of Halpern Financial in Ashburn, Va., Likes low-cost, short-term municipal bond funds like the JPMorgan Short-Intermediate Municipal Bond Fund (JIMIX), which has a net expense ratio of 0, 25% and an average of 52 weekly return of 1.41%. Short-term municipal bond funds offer tax-free interest and better rates than CDs without locking in the money for a fixed term. This is especially important if rates go up, he says. “Munis is very attractive now because states are well capitalized after receiving several rounds of stimulus payments. “
In a pinch, your home could be a source of money. A home equity line of credit costs only a few hundred dollars to open, and some lenders waive closing costs and maintenance fees if the loan is tied to a checking account at the same financial institution. The HELOC should be in place before you retire, when your income is relatively high and your credit is good, says Harris. “Don’t touch it. Have it there just in case of an emergency.” Home equity line of credit rates are typically about a point above the prime rate, or slightly above the rate of inflation, with interest payable only if you withdraw money from the HELOC.
Likewise, you can set up a securitized line of credit linked to your investment account with no closing costs, says Halpern. Like HELOC, you only pay interest on the balance you draw on the line of credit.
The more credit you can use immediately, the lower your reserves must be in other emergency accounts. Halpern recommends keeping the equivalent of two months of spending in bank accounts and a month or more in a bond fund, in addition to lines of credit.
Periodically review the size of your emergency fund and increase your savings to cover planned expenses, such as a home improvement project or the purchase of a car, says Sunit Bhalla, a certified financial planner in Fort Collins, Colorado. Keep in mind that “the more frugal you are in life, the less you need your emergency fund,” says Derek Sall, who blogs at Life And My Finances in Grand Rapids, Michigan.