Where to Hide Your Emergency Fund to Protect It From Inflation
Aside from a checking account, is there a good place to put emergency cash so it doesn’t get eaten up by rising inflation? Unfortunately, with interest rates being so low, the lucre is small, but you have several options: money market accounts, high yield savings accounts, and CDs. Here’s a look at how they work.
First, why is the emergency fund so important?
Financial advisors usually recommend keeping a cash fund of at least 3-6 months of your emergency expenses . The reason for this is that unlike long-term investments such as index funds or bonds, you will need readily available or “liquid” cash if you ever need it. And since it just sits there, you can maximize the interest that will be charged to your balance. But where do you start?
High Yield Savings Account
Most people are familiar with savings accounts , which are similar to the regular checking account you use for debit fees, except that it has more restrictions on withdrawals (“high yield” is a term that simply describes accounts that offer the best interest rates).
Typically, the number of withdrawals you can withdraw from your savings account is limited to six per month. Exceeding this limit may result in a payment, therefore savings accounts are not used for daily transactions. Currently, high yield accounts offer an interest rate of return (APY) of about 0.50-0.60% .
Money market account
A money market account is a kind of hybrid of checking and savings. 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 APY closer to 0.60% , which is comparable to high yielding savings accounts. The trade-off is that transaction fees may apply, and a larger deposit is often required to open an account, usually somewhere around $ 2,500.
Certificates of Deposit (CDs)
CDs are a tricky option because they offer better interest rates compared to money market and savings accounts, but they are less liquid because you commit to freeze your money for a period of several months to five years, depending on which you choose (and there is a commission for early withdrawal ). You can find rates from 0.70% per annum for one year and up to 1% per annum for two years.
This option may not work for your emergency fund, but it can be a good way to spend your money on other things, such as a trip or another major purchase you are planning in a year.
Bottom line
Unfortunately, with interest rates so low, you can do very little to mitigate the effects of inflation. This is why many people try to minimize the amount of cash they have, usually investing in long-term investments like index funds.
But for the cash you hold, you might as well maximize your interest rate. Depending on the size of your deposit, what the money is for, and whether you need some flexibility in using it, any of these types of short-term savings accounts might be a good option for you. Sure, a difference of half a percentage of a thousand dollars is likely to result in an accumulation of interest of $ 50 or less for a given year, but why not take what you can get?