Where Should You Save An Emergency Fund?

I was enjoying coffee with a friend this morning, and they mentioned the capital deployment of their emergency fund. So, where should you save an emergency fund?

Emergency Fund Basics

“An emergency fund is a stash of money set aside to cover the financial surprises life throws your way. These unexpected events can be stressful and costly.”

An emergency fund is a financial safety net for future mishaps and unexpected expenses.

Here are some of the top emergencies people face:

  • Job loss.
  • Medical or dental emergency.
  • Unexpected home repairs.
  • Car troubles.
  • Unplanned travel expenses.

Remember, emergency funds are for ACTUAL emergencies. They are not for Black Friday shopping deals. They are not for vacations. It is for true emergencies, not for wants!

Government Shutdown Lesson

I wrote an article titled “Lessons From the Government Shutdown” during the January tragedy.

The reason the government shutdown was as harmful as the media displayed is because 78% of Americans live paycheck-to-paycheck.

The reality of that number is almost incomprehensible. 3 out of every 4 people you encounter daily would not be able to withstand a loss of their paycheck.

A similar studied was conducted earlier this year that determined 40% of Americans would not be able to cover an unexpected $400 expense. So, what does this mean?

Any expense, hiccup, or rainy day for 40% of Americans will derail their financial plans.

Heck, any car maintenance is going to cost you at least $400, and a medical emergency or unemployment will devastate you financially.

How Much?

An emergency fund should contain enough money to cover between three and six months’ worth of expenses, according to most financial planners.

If you have debt, Dave Ramsey recommends saving a starter emergency fund of $1,000 first.

Then, once you’re debt-free, he suggests beefing up the savings to build a fully funded emergency fund of three to six months of expenses.

Revisit Purpose

The reason to have an emergency fund is simple. You don’t know what you don’t know! Life happens, simple as that.

No one wants to live at the mercy of life’s twists and turns. Your emergency fund will come in handy if you suddenly lose your job, contract a medical illness or your heating system breaks during the polar vortex.

Don’t let yourself be caught off guard! You need that safety net. It literally can be a matter of life and death!

Liquidity

Liquidity describes the degree to which an asset can be quickly bought or sold in the market at a price reflecting its intrinsic value.

In other words, the ease of converting it to cash.

Cash is universally considered the most liquid asset, while tangible assets, such as real estate, fine art, and collectibles, are all relatively illiquid.”

where should you save an emergency fund

You want your emergency fund easily accessible because most emergencies require payment upon fulfillment.

You NEVER want to put an emergency expense on a credit card that will charge 20%+ in interest.

Remember our rule of thumb. Debt is like fire, and it should only be used when it can make you more money when deployed on productive purposes.

Debt should never be used for personal consumption.

Risk Tolerance

Ever heard the saying that “catastrophes come in threes”? This is exactly what will happen during an economic downturn.

A majority of individuals will lose their jobs, see their home prices plummet, and their investment portfolios sliced.

This is what happened during the recession of 2008, and it provides a clear, empirical case for why an emergency fund should never be invested.

While the stock market carries a positive expected return, it’s volatility (measured by standard deviation) is much higher than risk-free assets.

Risk-free assets include Government Treasuries and FDIC insured bank deposits. Thus, the only risk is inflation rising faster than the interest rate.

Which, in our current macroeconomic environment of quantitative easing and cheap money, is a real risk. However, the expected return carries a standard deviation of 0!

Dave Ramsey discusses the paradox behind investing your emergency fund.

“Your emergency fund is not an investment. It’s insurance. Insurance costs you money to protect your investments.

That’s what insurance does. The money you have sitting there just for emergencies is not there to make you money.

It’s there to protect your investments because if you don’t have the emergency fund, you will borrow money and pay out interest and horrible terms to some stupid bank.”

High Interest Savings Account

Now, where should you save an emergency fund?

“A high-yield savings account is a type of savings account that typically pays 20-25 times the national average of a standard savings account.

Traditionally, people have held a savings account at the same bank where they hold their checking account, making transfers between the two easy and quick.”

My Wells Fargo checking account pays approximately 0.05% in checking. However, Wealthfront and Ally pay approximately 2%.

You just want to make sure any place you store your emergency fund is FDIC insured. This eliminates money-market accounts.

Here are a a few of my favorite high-yield banking accounts:

  • Wealthfront
  • Ally
  • CIT Bank
  • Marcus by Goldman Sachs

Conclusion

So, where should you save an emergency fund? You should you use a high-interest savings account.

NEVER, EVER, EVER invest your emergency fund. It is your insurance against a downturn!

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