Best banks for emergency funds: Expert guide on accounts
Life is rarely predictable. Your car needs a major repair, or you have unplanned medical bills, and you need quick access to cash to avoid burdensome debt. An emergency fund is designed to cover unexpected expenses, ensuring you have the resources to handle surprise costs without financial strain.
Setting aside additional money is crucial so you’re prepared for whatever comes your way. Without an emergency fund, you may face financial hardship, relying on high-interest debt or struggling to pay essential bills. Having a fully-funded emergency fund provides peace of mind in these situations where you don’t want to rely on high-interest credit cards. Experts typically recommend having an emergency fund of at least three months of living expenses, if not closer to six or more months. If you’re uncertain of where to put your emergency savings, some places are better than others. This guide outlines the best accounts for your emergency fund to help you optimize your savings.
What makes an ideal emergency fund?
The best banks for emergency funds share several commonalities. Ideally, where you house your emergency savings will satisfy all areas. Here’s what to look for in a bank for your emergency fund.
Safety: Selecting a bank or credit union that offers Federal Deposit Insurance Corporation (FDIC) or National Credit Union Association (NCUA) coverage, respectively, is best for any savings. The best accounts are FDIC-insured, providing an extra layer of security. Both offer protection of $250,000 per depositor, per account ownership category. Most banking products receive this protection, but typically not investment-type products. Insurance coverage is crucial to ensure your emergency fund is protected against bank failure.
Liquidity: Quick access to cash is essential in emergencies. You want an account that is easily accessible and provides fast and easy access to your savings.
Minimal risk: You’re not building wealth with emergency savings. Instead, you’re protecting yourself. Investments typically shouldn’t be a part of your emergency fund.
Fee-free withdrawals: Some banks impose fees if you withdraw or transfer funds out of your savings account over a certain number of times each month. These bank fees can needlessly erode interest. It’s best to select a bank that is more lenient on such penalties.
In short, the best way to store emergency savings is having appropriate liquidity while offering a competitive interest rate with zero fees.
5 best places to keep your emergency fund
Regardless of whether you’re just beginning or you have a fully stocked emergency fund, where you park that cash matters. Building wealth isn’t the purpose of this cash, but it’s wise to try and earn enough interest to keep pace with inflation. Choosing accounts that allow you to earn interest, such as high-yield savings accounts or money market accounts, can help your emergency fund grow while remaining accessible. When comparing high-yield savings accounts and money market accounts, both offer the benefit of earning interest on your emergency savings while maintaining liquidity. The right account can maximize your interest earnings, providing additional income on your emergency fund over time. Unlike traditional savings accounts, which typically offer lower interest rates, high-yield savings and money market accounts provide better returns and features suitable for emergency funds.
These are the best accounts for an emergency fund:
1) High-Yield savings accounts
A high-yield savings account is often the best choice for an emergency fund, as it typically pays the most competitive interest rates. The best high-yield savings accounts often pay upwards of 4-5%, depending on your balance, far outpacing what’s often available at a brick-and-mortar bank.
You can find high-yield accounts online, and most have minimal fees and low minimum balance requirements. And, most offer the same FDIC coverage as do local banks.
Many online banks don’t offer checking accounts, so you will need to wait for transfers to your main bank, which is typically one business day. High-yield savings accounts are ideal for individuals seeking competitive rates and a single location for their savings.
2) Money market accounts
Money market accounts are a blend of checking and savings accounts. You may even find some banks offering check-writing or debit card access as a feature of money market accounts. It’s not uncommon to see rates on money market accounts compete with those available in high-yield savings accounts.
Money markets enjoy the same FDIC/NCUA coverage. Unfortunately, some banks cap the number of monthly transactions or have higher minimum balance requirements. Money market accounts are ideal for savers seeking decent interest rates with limited check or debit card access.
3) Local bank or credit union savings
Your local bank is a reliable place for an emergency fund. Brick-and-mortar branches extend FDIC/NCUA coverage, have minimal account balance requirements, and provide easy access to cash.
You pay for that peace of mind with substantially lower interest rates compared to an online high-yield savings account. Selecting a local bank account isn’t a bad choice, per se, but it’s usually a better option as a backup to your main savings account.
4) Money market mutual funds
Another option for your emergency fund is a money market mutual fund, which is often part of a brokerage account. The funds are historically liquid, offering next-day or same-day access, and invest in CDs, savings accounts, or short-term bonds. You’ll likely find rates somewhat higher than what’s available in a traditional savings account.
However, these account types are not FDIC/NCUA insured. And, while rare, it’s possible to lose your principal investment in these accounts due to market volatility. Money market mutual funds are best for investors with an appetite for minimal risk.
5) Certificate of deposit (CD) ladders
Finally, with the right strategy, CD ladders can be a good choice for emergency savings. CDs require you to keep cash in the account for a given period, usually months to years, in exchange for a guaranteed interest rate, typically a fixed rate. Your earnings are predictable, and you get FDIC/NCUA protection.
Laddering CDs involves dividing your funds into equal parts and investing it in CDs with staggered terms. When each CD matures, you reinvest the funds in another CD, unless you need access to the funds upon maturation. Yields are typically higher than those of a traditional savings account.
CDs often fall short as they typically lock up your cash, and penalties may apply if you try to access funds early. The lack of flexibility may be a problem for some. CD ladders are best suited for individuals with substantial funds who don’t anticipate an immediate need.
What are the best high-yield savings accounts?
Where not to put your emergency fund
Just as important as knowing the best bank accounts for your emergency fund is knowing those to avoid. Some account options may result in the loss of funds or the inability to manage an emergency. These are accounts that aren’t a suitable choice for emergency savings.
Savings bonds, while they pay interest, are not suitable for emergency funds because they have limited liquidity and may impose penalties for early redemption.
Investment accounts that are tied to the stock market can be risky and are not appropriate for emergency funds, as the value can fluctuate and you may not have access to your money when you need it most.
A retirement account, such as a 401(k) or IRA, is not appropriate for emergency savings due to penalties and restrictions on withdrawals. Retirement accounts should always be kept separate from emergency funds to ensure your long-term financial security is not compromised.
Checking accounts
Leaving emergency savings in your checking account seems like a reasonable choice. It ensures easy access to your funds in case of emergency, and you don’t risk fees if you withdraw money too many times during the month.
You pay for that convenience, as it makes your emergency fund too accessible, making it possible to mindlessly spend your rainy day fund.
Worse yet, it’s not uncommon for checking accounts not to pay interest. If they do, the rate is often minimal at best. On the other hand, a high-yield savings account usually pays a competitive rate that may keep pace with inflation. Keeping a small buffer in your checking account may be wise, depending on your situation, but it’s best to keep it at that.
Investment accounts
Growing your wealth is a necessary goal for most people, but that’s not the purpose of an emergency fund. Emergency savings help in the event of a large, unplanned expense. Although the historical growth of the S&P 500, as one example, is 10% annually, it’s not a guarantee.
Placing your emergency fund in stocks or ETFs at your online brokerage exposes you to the risk of capital loss. Additionally, it can take several business days to access funds and if you sell an investment for a gain you’re liable to create a taxable event. Focus on stock investments for long-term growth, not for emergency savings.
Long-term CDs without a ladder strategy
Using a CD ladder for your emergency savings can be advantageous when done correctly. That said, while CDs often offer competitive interest rates, their benefits are limited beyond that.
A traditional CD locks up your funds for the given timeframe. For example, if you have a two-year CD, you often can’t access the funds without paying early withdrawal penalties and sacrificing interest. No-penalty CDs are a legitimate substitute, but those may pay less interest and still have some restrictions.
Frequently asked questions about emergency fund accounts
Having a fully stocked emergency fund is key to avoiding financial troubles. These are common questions people have when considering saving for emergencies.
Most situations are unique in personal finance, but it’s smart to follow wisdom with emergency funds. With that in mind, it’s prudent to save three months’ worth of living expenses if you’re single, six if you have dependents, and nine if you’re income is irregular, such as if you’re self-employed or depend on commissions.
Although it requires additional time to manage, having multiple accounts is a sound choice. Having some funds in a high-yield savings account and some in a money market account, for example, can balance yield and accessibility. A good rule of thumb to follow is having at least one-third of your savings instantly accessible.
It’s advisable to keep at least one to two months’ worth of living expenses immediately accessible. You could leave this at your local bank while keeping the balance of your emergency savings in a high-yield savings account to maximize interest.
Bottom line
There are many options for establishing an emergency fund. It can be overwhelming to know which is best to maximize potential return and still be there when you need access to cash.
Keep in mind that not all financial accounts are well-suited for all situations. You want to select an account with minimal risk that won’t penalize you for withdrawals while also paying a competitive interest rate. Identifying the best savings accounts or money markets can go a long way towards making it easy to save and achieve financial goals.
