Setting aside cash to cover emergencies is one of the best financial moves you can make. Important, unexpected expenses will come up, and being prepared with enough cash to deal with them will give you peace of mind and keep you from racking up debt.
Emergencies include high medical bills, essential home repairs, a plane ticket to see a loved one in need, job loss and any other unexpected problem that requires a significant cash infusion. A fund that you can quickly tap into will prevent you from having to borrow your way out of the problem.
Ideally, you'll have at least three months' worth of essential expenses at your disposal, and more if people are depending on you for their care. The total may be many thousands of dollars.
As you amass money for your emergency fund, you'll need to keep it someplace safe, somewhat accessible and free of costly fees. As much as you may want your savings to grow rapidly, this particular type of savings shouldn't be held in a risky investment account or tied up in real estate since the funds may be devalued or delayed when you need them. Cash held in a checking account is too easy to spend. And don't even think about stashing it under your mattress, where it's susceptible to theft and natural disasters, and won't earn any interest. So where are you going to keep your precious emergency savings? You have a number of great options.
High-Yield Savings Account
The first and easiest place to stash your cash is a savings account that offers an especially high interest rate (called the yield). The best places to open these high-yield savings accounts are credit unions and online banks, though some brick-and-mortar banks also offer them.
Depending on the financial institution you choose, today's high-yield rates are 2% or more—significantly higher than what you'd earn with standard savings accounts, which currently offer well under 1%. If you deposited $10,000 in a savings account offering 2.25%, it would grow to $10,227 after a year.
Most high-yield savings accounts are fee-free, though some require a minimum deposit (but it's rarely more than a thousand dollars). A few even come with a one-time cash bonus as an incentive.
Money Market Account
Money market accounts are a type of savings account that also offers higher interest rates than standard savings accounts. You can open one at most banks and credit unions. Money market accounts are typically a mix between a checking and savings account because you can write a certain number of checks against them each year.
To open a money market account, you may have to make a deposit of anywhere from $100 to many thousands of dollars depending on the financial institution. Like high-yield savings accounts, there are no penalties to pull out the funds, and you can do it at any time. Unlike high-yield savings accounts, they may come with maintenance fees, as well as a monthly minimum balance requirement.
Yet another option is to buy Treasury bills (T-bills) with the money you have accumulated. These short-term debt obligations are backed by the U.S. Treasury Department. T-bills are typically sold in denominations of $1,000 and are available for purchase from the U.S. Treasury Department's TreasuryDirect site, a broker or a bank.
They work by you buying the T-bills for less than their face value, and when they mature (in one year or less) you can sell them at their face value. The amount you paid for them versus what you sold them for is your earnings. For example, if you buy a T-bill for $9,500 with a face value of $10,000 and keep it until it matures, $500 would be your guaranteed profit. Even more exciting is that the gains are exempt from state and local taxes, which gives them added value (you will pay federal taxes on the gains, though).
Although interest is only paid at maturity, you can sell T-bills before that date if you really need the cash quickly. There won't be a penalty, but if you do sell them early, there is a possibility that the sale price will be lower than the original purchase price.
Certificates of Deposit
Certificates of deposit (CDs) are another good place to keep your emergency savings. They offer an elevated interest rate in exchange for setting your money aside at the bank for a short period of time, called the term. You can get CDs from just about any financial institution.
If you have a 12-month CD with a guaranteed rate of 2.5%, a $10,000 investment would grow to $10,253 after a year. However, if you need to take your money out early, you will forfeit a certain number of months' accumulated interest. To avoid this problem, you can buy multiple CDs with different maturity dates, from months to years. This way you can have access to your cash without having to give up any of your interest.
Clearly you have a number of excellent and secure locations for your emergency savings. In fact, there's no harm in spreading the money among all or a few of them. Just don't make it so complicated that keeping track becomes a chore or confusing. You'll want to know where your money is, and when and how you can safely extract it should an emergency arise.