Four Smart Places to Stash Emergency Cash
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"Emergency cash is generally considered to be cash that you would need within six months to one year," says Theresa Rosen, a certified financial planner with Prudence Financial in Sudbury, Mass. "The key is that it is accessible, or liquid."
That means stocks and mutual funds are out, leaving you with safe, liquid accounts that often don't offer much of a return. Today's near-rock-bottom interest rates have savers searching for alternatives.
Here's a look at some options for your emergency cash for both business and personal purposes.
Bank Savings Accounts
Your basic bank savings account is a good place to start, but you shouldn't expect much in terms of earnings on the account. In this low-interest-rate environment, plain vanilla bank savings accounts don't pay much at all. Today's average for savings accounts is 0.21 percent, according to BankRate.com.
The trade-off is that these accounts offer safety. The Federal Deposit Insurance Corporation insures deposits in banks and thrift institutions for up to $250,000 per depositor, per insured bank. The FDIC is a government agency that protects depositors against loss if the financial institution fails. In some cases, you can be insured for more, so ask your bank about your accounts.
Safety, easy access to funds and the ability walk into a branch if you have a problem are the main advantages of working with your local bank. You can also easily transfer funds from a bank savings account to other accounts you have.
If you're not disciplined, though, the ease of moving funds can be a negative.
Emergency funds are for emergencies. If you feel too tempted to tap that account for nonemergency expenses, you may be better off with another option. (See CDs and T-Bills, below.)
To get the best rates, shop around.
"Don’t settle for average. Seek out better yields offered at online banks, community banks and credit unions to get the best return on your money," says Greg McBride at BankRate.com.
Also check out savings accounts offered by banks in other areas of the country. Check BankRate.com for a listing of the highest-paying accounts.
Money Market Accounts/Funds
In today's climate, money market accounts are paying about the same as savings accounts. The average rate is 0.20 percent, according to recent BankRate.com reports.
Like savings accounts, money market accounts will give you pretty easy access to your cash in the form of checks, ATM cards or transfers.
Money market accounts are offered by most banks, but you may do better if you're willing to branch out online. Check BankRate.com for its survey of the highest-paying money market accounts.
"Although interest rates are at record lows, you can get better returns on your money by shopping around," McBride says. "Doing so will lift a return of 0.3 to 1.3 percent, while maintaining access to the money and FDIC insurance protection."
Also take a look at accounts offered by low-cost investment companies such Charles Schwab.
If you go with a brokerage company, make sure you know what you're getting. Many institutions offer both money market accounts, which are FDIC-insured, and money market funds, which are not.
Money market funds can also work as a parking place for emergency cash, but these are actually mutual funds, not bank accounts. They generally pay a higher interest rate than money market accounts because they take on slightly more risk by investing in short-term debt securities. These funds have a goal of maintaining a $1 share price, but there is no guarantee.
Certificates of Deposit
Certificates of Deposit, or CDs, are another option.
These are FDIC-insured investments offered by financial institutions. You essentially lend the institution money in exchange for a set interest rate over a specific time period. These time periods, ranging from three months to several years, are known as maturities. Shorter maturities offer lower interest rates, while longer maturities offer higher ones.
You can cash in a CD at any time, but if you take your money out before the maturity date, most CDs have an early-withdrawal penalty. To avoid the penalty, consider keeping some of your money in a savings or money market account so you have some access to cash instantly, while leaving some other funds in CDs.
Tying up your emergency money in a long-term CD isn't smart. Instead, consider laddering CDs, a strategy of staggering the maturity dates across several CDs. For example, buying a three-month, six-month, nine-month and a year-long CD would mean you'd have money coming available every three months. The longer-maturity CDs would pay a higher rate of interest than the shorter-term ones.
U.S. Treasury bills, or T-bills, offer the safety of the full faith and credit of the U.S. government. Despite the current economic troubles, few believe the U.S. will ever default on its bills.
These bills are sold in varying maturities, ranging from a few days to 52 weeks. When you buy, you buy at a discount. For example, you may pay $990 for a $1,000 bill. At maturity, you'd receive $1,000.
Similar to laddering CDs, you can stagger the maturities of T-bills to make sure you have bills maturing at regular intervals so you can take advantage of varying interest rates and have money available when you need it.
You can purchase these directly at Treasury Direct.
Bond mutual funds are another investment some consider for emergency funds. People hear the word bonds and think safety, but that's not always the case. It depends on the types of bonds in which the fund invests.
Some treasury bonds invest in riskier corporate junk bonds, others invest in much safer U.S. Treasuries. While you could pull your money out of these funds any time, you may face a redemption fee if you make a withdrawal too early after your initial investment. And that doesn't account for potential declines in value over the short term (often in periods of rising interest rates--which many market watchers believe we may see in the coming years).
Also remember that your emergency fund investment doesn't have to be an all-or-nothing proposition. Rosen says you could layer the cash by using a variety of cash equivalents: bank accounts, money markets, very short-term bond funds and Treasury bills or notes.
Other Cash Options
If you don't have enough cash in an emergency fund, there are some stop-gap measures you can consider.
None of the following options are as good or financially stable as simply saving until you have enough in the bank or other account for emergencies.
If you own a home, apply for a home equity line of credit. Securing one will allow you to tap your home equity in times of emergency, often with a simple checkbook linked to your line of credit. The interest is tax-deductible, but if you're unable to make the loan payments, you could put your home at risk.
Another option is borrowing from credit cards, but that means paying a higher interest rate than other loans or home equity borrowing. In most cases, it isn’t a good idea to turn to credit cards until you've exhausted all other options for emergency cash. If you can't pay off your credit card quickly, even a balance on a low-interest-rate card is likely to grow rapidly.
Instead of borrowing, start slow. Use an automatic investment program in which you direct your bank to transfer a set amount each week or each month to a temporary parking place to build your emergency fund. When the account has grown, transfer those funds to a higher-interest-paying account.