How to Wisely Invest Your Emergency Fund

July 8, 2013

emergency fund investingAre you ready for a rainy day?

The day when the roof leaks, the air conditioner goes out, or the transmission in your car finally dies you will need a pile of cash sitting around to pay for that emergency.

Most financial pundits recommend 6 to 12 months of your expenses as an example of a fully-funded emergency fund. Of course getting to that amount might mean thousands of dollars and months of saving, but the benefit of having the money there when you need it is invaluable. Avoiding credit card debt during a tough financial season can mean a lot.

Investing Your Emergency Fund

Having that many months might mean you need $20,000 or $25,000 sitting somewhere and your instinct is to try and maximize the return on that money rather than just leaving it sitting there. Here are some tips on how to make wise choices as you look to invest your emergency fund.

Principal Protection Trumps Rate of Return

Maximizing the return on a big sum of cash is a fine idea, but be careful. The general rule of thumb with investing is the more reward you want the higher risk you need to take.

This is your emergency fund. Risk should not be part of the equation. The main benefit of having an emergency fund is . . . having an emergency fund. It isn’t the return that is generated off of investing your emergency fund. Simply having it and contributing enough each year to keep up with inflation is a win.

A majority of people live paycheck to paycheck, so by taking the time and effort needed to build up an emergency fund in the first place you are way ahead of the game. Don’t try to stretch a little bit further ahead by taking on risky investments. You could end up wiping out a big chunk of the fund and leave yourself in a financial bind.

Safe Investments for Emergency Fund

There are two primary safe investments you can use with your emergency fund without thinking twice. They won’t generate monster returns – they may not even keep pace with inflation – but the point is they will keep your fund safe.

Certificates of Deposit

A CD at a bank or credit union will earn a decent interest rate while keeping your funds safe. What is great about putting your emergency fund into a certificate of deposit is there is a penalty for withdrawing funds early. You would think you wouldn’t want to forfeit some interest to get your hands on your money in an emergency, but putting up a barrier makes it less likely you’ll raid the fund for non-emergency purposes.

Online “High Yield” Saving Accounts

Likewise you can enjoy a little bit more liquidity than a CD by using an online savings account. These used to be called high yield accounts because you could get 3% to 5% or more just for having a savings account. Those rates haven’t existed in a while thanks to the Federal Reserve.

Nevertheless, you can earn a decent return (albeit somewhat lower than a long-term CD) and have easier access to your funds if you need them. You just need to be careful not to constantly be pulling money out for small “emergencies.”

Do you plan on getting an emergency fund? Where will you invest it?

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Kevin

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Kevin
Kevin Mulligan is a debt reduction champion with a passion for teaching people how to budget and stay out of debt. He's building a personal finance freelance writing career and has written for RothIRA.com, Discover Bank, ING Direct, and many others.

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One Response to How to Wisely Invest Your Emergency Fund

  • Sean Hollywood

    Two factors should play in investing emergency funds, liquidity and protection of principal. CDs might offer better returns (barely), but what happens when you have a major catastrophe and need access to those funds quickly. Stocks are liquid but may have an unacceptable risk. Even bonds present some risk for principal reduction. We keep ours in a savings account with an online bank. The returns aren’t too bad and they are still quite liquid.

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