An emergency fund serves as a financial safety net, providing liquidity when unexpected expenses arise, such as medical emergencies, car repairs or job loss. While most people keep their emergency funds in a traditional savings account, you may also consider investing your emergency funds. Done well, this can boost returns while maintaining access to your funds. A financial advisor can also help you develop an emergency fund investment strategy.
Emergency Fund Basics
An emergency fund is a dedicated amount of money set aside to cover unexpected expenses. This can help you avoid relying on credit cards or high-interest loans during a financial emergency. Having a well-funded emergency account provides peace of mind and financial stability in the face of unexpected costs.
Most financial experts recommend having three to six months’ worth of living expenses saved in your emergency fund. The amount that is appropriate for you will vary depending on your personal circumstances, such as your job stability, monthly expenses and whether you have dependents. For example, if you have a mortgage, children or medical expenses, you might aim for the higher end of that range.
It’s also important that your emergency fund remains liquid, meaning you can access the money quickly when needed. This is why many people opt for a traditional savings account, which offers easy access to funds. However, with interest rates on savings accounts remaining relatively low, some people are exploring other low-risk investment strategies to help grow their emergency savings over time.
6 Emergency Fund Investment Strategies to Consider
Here are six common emergency fund investment strategies to consider if you’re looking to earn more on your savings without sacrificing liquidity:
- High-yield savings accounts: A high-yield savings account is one of the most popular and low-risk options for your emergency fund. These accounts function like traditional savings accounts but offer significantly higher interest rates, often ranging from 0.50% to 4% depending on the bank. The funds in high-yield savings accounts remain easily accessible, and most accounts are FDIC-insured, meaning your money is protected up to $250,000.
- Money market accounts: Money market accounts combine the benefits of a savings account with limited check-writing capabilities. They often offer slightly higher interest rates than traditional savings accounts and are also FDIC-insured. While money market accounts typically require a higher minimum balance, they provide a safe place to park your emergency fund while earning some interest.
- Certificates of deposit (CDs): Certificates of deposit, or CDs, are another low-risk option for investing your emergency fund. With a CD, you agree to leave your money in the account for a set period from a few months to several years in exchange for a fixed interest rate. While CDs generally offer higher interest rates than savings accounts, your funds are locked up for the duration of the term. However, you can create a CD ladder of CDs with different maturity dates to ensure some liquidity while maximizing returns.
- Short-term bond funds: Short-term bond funds are mutual funds that invest in bonds with maturities of one to three years. These funds offer the potential for higher returns than savings accounts or CDs, though they also carry more risk. Short-term bond funds tend to be less volatile than stocks and long-term bonds, making them a viable option for those looking to grow their emergency fund without exposing it to significant risk. Just keep in mind that bond values can fluctuate, so there’s a possibility of losing some principal.
- Treasury bills (T-Bills): Treasury bills are short-term government securities that mature in one year or less. When you purchase a T-bill, you are essentially lending money to the U.S. government, which then repays the loan with interest. T-bills are one of the safest investment options, as they are backed by the full faith and credit of the U.S. government. While the returns may not be substantial, they offer a secure way to invest your emergency fund and typically provide better yields than a savings account.
- Robo-advisors with conservative portfolios: If you’re comfortable with a little more risk, you can use a robo-advisor to invest your emergency fund in a conservative portfolio. Robo-advisors use algorithms to create and manage investment portfolios based on your risk tolerance. A conservative portfolio will typically include a mix of bonds and low-risk stocks. While this strategy has the potential for higher returns, it’s important to remember that the stock market can be volatile, so this option is best for those with a higher risk tolerance and a large emergency fund.
How to Build an Emergency Fund
If you don’t have an emergency fund yet, or your current fund needs some growth, here are five practical steps to start building one:
- Set a savings goal: Begin by determining how much you need to save. Aim for three to six months’ worth of living expenses as a starting point. This should include essentials like rent or mortgage payments, utilities, food and other necessary bills. If your income is variable or your job situation is uncertain, consider saving closer to six months’ worth of expenses.
- Automate your savings: One of the easiest ways to build an emergency fund is by automating your savings. Set up automatic transfers from your checking account to your savings account on a regular basis, such as after each paycheck. Even small, consistent contributions will add up over time.
- Cut unnecessary expenses: Take a look at your current spending and identify areas where you can cut back. Whether it’s dining out less frequently or canceling subscription services, divert the money you save into your emergency fund to help it grow faster.
- Use windfalls: Whenever you receive extra money, such as a tax refund, bonus or monetary gift, consider putting a portion of it into your emergency fund. Windfalls can provide a significant boost to your savings without affecting your day-to-day budget.
- Stay consistent: Building an emergency fund takes time, but the key is to stay consistent. Even if you can only save a small amount each month, the important thing is that you are making progress toward your goal.
Bottom Line
How you choose to store or invest your emergency fund can make a big difference in its growth and accessibility. Options for generating higher returns from an emergency fund include high-yield savings accounts, short-term bonds, Treasury bills and conservative robo-advisor portfolios. Whatever you use, the key is finding a strategy that balances safety and returns.
Tips for Financial Planning
- A financial advisor can help you create a personalized financial plan. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- If you want to know how much your certificate of deposit could earn, SmartAsset’s CD calculator could help you get an estimate.
Photo credit: ©iStock.com/katleho Seisa, ©iStock.com/GaudiLab, ©iStock.com/miniseries