It is always a good idea to keep some money set aside for difficult times in liquid investments. It is a double-edged sword, however, because the more liquid your money, the less it is earning in interest.

Most importantly, if you do not set aside money for an emergency fund, you miss out on substantial earnings. So what should you do?

Key Takeaways:

  • An emergency fund should strike a balance between earning interest and allowing easy access to money.
  • Stocks can be volatile, and selling them in an emergency can lead to a loss.
  • It is advisable to keep three to six months’ worth of expenses in a checking or money market account with check-writing privileges.

Understanding What Is Safe and Liquid

When considering liquid investment options, make sure you can access the money quickly, easily, and without a withdrawal penalty. Most financial professionals do not recommend investing your emergency fund in the stock market because stocks, as the world just learned only two well during the coronavirus outbreak, are volatile. It would be unfortunate to have to sell an investment at a loss to access your emergency fund.

Bonds are generally a poor choice for similar reasons, although they are generally less volatile than stocks. Dave Ramsey, the longtime host of a financial advice radio show, author of several personal finance books, and designer of programs to help individuals get out of debt, recommends that individuals keep three to six months’ worth of expenses in an emergency fund.

Ramsey further advises that your fund should be in a checking or money market account that has debit card or check-writing privileges, so you can quickly and easily pay for an emergency expense.

Investment Possibilities

The problem is that money in a traditional checking account at a brick-and-mortar bank will earn little or no interest in today’s low-interest-rate environment. When you are not earning interest, you are losing money to inflation every year.

Ideally, your emergency fund would at least be earning 2% to 3% per year to keep pace with inflation, but when even savings accounts are barely paying any interest, this is a difficult task. So how can you get as far away from 0% and as close to 2% or 3% as possible while still keeping your emergency fund highly liquid and not putting it at risk?

Money Market Accounts

Favoring money market accounts over checking accounts may help. Many are insured by the Federal Deposit Insurance Corporation (FDIC), and the ones that are not typically have pristine records and tend to pay more interest than checking or conventional savings accounts.

Some leading online banks, such as Synchrony, offer money market accounts that come with debit card and/or check-writing privileges, which gives you instant access to your funds.

High-Yield Savings Accounts

If you can trust yourself not to spend your emergency fund on things it was not intended for, keeping it in a high-yield savings account at a brick-and-mortar bank where you also have a checking account should allow you to transfer funds from savings to checking instantly. Also, you can access money via debit card, ATM, or check in an emergency.

A high-yield online savings account is another option for your emergency fund. Money in an online savings account is FDIC-insured, and online accounts typically pay more interest than brick-and-mortar accounts, as online banks do not have the overhead expenses of traditional banks. Just make sure you know how to access your money in an emergency, as you will not be able to walk up to a bank teller and make a large withdrawal.

Ally Bank, for example, says you can access the money through an online funds transfer, outgoing wire transfer, telephone transfer, or check request. Other methods of accessing emergency savings in an online account may take several days, and you may not be able to wait that long. 

Of course, the more you deposit, the more you will earn. Still, make sure the account you are considering does not require you to have a higher balance than you plan to maintain to get the interest rate you’re looking for. If you only have $1,000 to put in your emergency fund, an account that pays high interest on balances above $5,000 won’t do you any good.

Another thing to watch out for is high introductory rates. They can be a great way to boost the interest earnings on your emergency fund in the short term, but will you want to keep your cash at that bank once the rate reverts to normal? How competitive is it? Banks count on the power of inertia—the fact that it’s easier to keep your account where it is rather than start looking for a better option.

Certificates of deposit (CDs) earn more interest than typical checking accounts, but you will pay a penalty if you cash out a CD before it matures.

Certificates of Deposit (CDs)

Consider a certificate of deposit (CD) to earn potentially even more interest. The problem with keeping an emergency fund in a CD is that you must pay the penalty to cash out a CD before it matures, and the CDs that pay the highest rates have the longest maturities, usually five years.

For example, the early withdrawal penalty on a five-year CD might be six months’ worth of interest. If you cash out the CD before you have even earned six months’ worth of interest, the bank may take the penalty out of your principal. If you keep your money in the CD for, say, three years before you have to cash it out, you may still earn more interest after the penalty than you would have with an online savings or money market account, depending on the rates each account is paying.

Some banks offer no-penalty CDs that let you withdraw your money without sacrificing any of the interest you have earned. You may earn a lower interest rate than you would with a regular CD, but a no-penalty CD does let you earn interest while still keeping your fund liquid. CDs are also FDIC-insured. Creating a CD ladder, where you buy several smaller CDs that mature at different intervals instead of one large CD, can help you avoid or minimize early withdrawal penalties.

Stocks and Bonds

You could invest your emergency fund in stocks and bonds to try to earn a higher return, but your money would be less liquid and subject to considerable risk. It can take several days for a sale to settle and the cash to be transferred to your checking account, where you can spend it.

Also, you never know if the market will be up or down when you need to sell. Putting some of your emergency funds in a less-liquid, higher-risk option might make sense only if you have a very large emergency fund and would not need to access all the money at once.