Every personal finance expert probably agrees that you should set aside some money as an emergency fund. The amount you should have in your emergency fund is a subject of debate, but the typical rule of thumb is to keep somewhere around 3-6 months worth of expenses. You never know what the future might hold, so it makes sense to at least have some buffer to keep yourself afloat in case something happens.
Since we can all agree that we should at least have some money in an emergency fund, the next important question is where should we put that money?
I basically see five places it could go:
- Checking Account
- Normal Savings Account
- Online High-Yield Savings Account
- Super High-Yield Savings Account (aka 5% Interest Savings Accounts)
- Investment Account
There are advantages and disadvantages to each. My guess is that most people will probably have their emergency fund in a combination of all of these accounts.
When I first started my emergency fund, I went with a mix of my checking account and an online high-yield savings account with Capital One 360. About a year ago, I made a switch, storing a small portion of my emergency fund with Ally Bank and keeping the majority of it in super high-yield savings accounts earning 5% guaranteed interest.
You know how people are always talking about not keeping too much money in their emergency fund because of the low returns? I don’t worry about that anymore.
Honestly, it surprises me that more people don’t take a little bit of time to get the maximum yield on their emergency fund. The difference between 0.75% and 1% interest isn’t worth making a switch. But the difference between 1% and 5%? I think that’s definitely worth looking into.
Let’s take a deeper dive into each of these emergency fund options.
1. Checking Accounts
Your checking account is likely the inbox of your financial system and is naturally the first place you might keep your emergency fund. If you’re pretty good with your money, you probably leave yourself a little bit of a buffer in your checking account. When you think about it, that’s basically the beginning of your emergency fund.
I definitely wouldn’t recommend keeping a huge buffer in your checking account simply because every dollar you keep in there probably gets nothing in return. Banks should pay you for your money, so if they’re not paying you, you shouldn’t reward them by giving them more money. I personally aim for about a $500 buffer in my checking account. You could totally do more or less as your buffer. I’d say just keep whatever amount makes you feel comfortable.
In terms of which checking account to use, you basically just want to make sure that whatever checking account you use has no fees.
Since banks should pay you for your money, it’s crazy to even think about paying a bank to hold your money. I personally go with a pretty big brick and mortar bank in my city. Like most big banks, they get terrible reviews. Still, they’ve never wronged me, so I just keep my money with them. Most traditional banks will have some sort of fee-free checking account option and it shouldn’t be hard to find a bank with a no-fee checking account.
Another potential option is to go with an online-only checking account. Ms. FP uses Ally Bank as her checking account. It’s totally free and they even pay a nominal amount of interest. I also have a second checking account with an online-only bank called Simple. Again, totally 100% free.
The one weakness with online-only banks is that it can be difficult to deposit cash. If you’re the type of person that never needs to deposit cash, then you could probably go exclusively with an online-only checking account. Since I sell about $1,000 or so worth of trash every year, I still need to be able to deposit at least some cash into my checking account. Hence why I still have my checking account with a traditional, big bad bank.
2. Normal Savings Accounts
These are the normal savings accounts that are typically offered by your regular brick and mortar banks.
My recommendation – don’t use these type of savings accounts. They offer ludicrously low interest rates, that personally, seems a little bit insulting. You might as well just keep your money in your checking account.
Instead, after your checking account buffer, the next bit of your emergency fund should be going into online, high-yield savings accounts.
3. Online High-Yield Savings Accounts
Online high-yield savings accounts got really popular in the mid-2000s. I remember when ING first launched its high yield savings account back when I was in high school and it offered something like 5% or more interest. Obviously, those days are done (or are they? keep reading!) but you’ll still get 100 times more interest from an online high-yield savings account compared to a traditional savings account. I’m guessing that most of you probably keep the bulk of your emergency fund in these type of savings accounts.
I personally recommend these two banks (both of which have absolutely no fees):
Either of these banks will work, although I prefer Ally more when it comes to emergency funds. First, they offer 1% interest, which is basically the highest amount you can get from a mainstream bank. (As we’ll discuss later, everyone can get 5% interest using super high-yield savings accounts). Second, they allow you to link up to 20 external bank accounts, which is very important if we want to take advantage of super high-yield savings accounts.
Capital One 360 is also a terrific choice. It’s where I originally stored my emergency fund all the way back when it was still ING Direct. The advantage with Capital One 360 is that it allows you to create multiple sub-accounts, which makes it much easier to sub-divide your cash savings.
Today, instead of keeping my emergency fund in Capital One 360, I use it mainly to hold money for my medium term goals.
4. Super High Yield Savings Accounts (aka 5% Interest Savings Accounts)
There’s a lot of debate about how much you should keep in your emergency fund. Naturally, every dollar that sits in your emergency fund is a dollar that you can’t invest.
Personally, I don’t have any problem with people keeping a ton of money in their emergency fund. That’s because every single person can earn 5% interest on up to $15,000 of their emergency fund in an FDIC insured savings account.
That’s $15,000 per person, so if you’re a couple, you can earn 5% guaranteed interest on up to $30,000. For most people, that’s a massive emergency fund that would probably cover any situation.
I’ve written about these accounts previously in more in-depth posts. These posts can be found below:
The interest you stand to earn is significant when compared to a normal high-yield savings account. Just take a look:
And remember, this is guaranteed interest that’s beating inflation by about 2% every year! That’s huge to be able to get that type of guaranteed return on an emergency fund.
If you’re someone who’s into travel hacking or otherwise optimizing your finances, then you should really take the time to understand how these 5% interest savings accounts work. Just like with travel hacking, it can probably seem intimidating at first. But once you set these accounts up, they basically run themselves. Most people will only need to look at their accounts once per year or never if they want.
Consider opening up your 5% accounts in this order:
- Insight (First Card = can save up to $5,000)
- Insight (Second Card =can save up to $5,000)
- Netspend (can save up to $1,000)
- Ace Elite (can save up to $1,000)
- Western Union (can save up to $1,000)
- H-E-B (can save up to $1,000)
- Brinks (can save up to $1,000)
If you max out all of these accounts, you’ll be looking at $15,000 earning 5% guaranteed interest in an FDIC insured bank account. If you’re a household, you’re looking at $30,000 earning 5% interest. The difference between 5% interest and 1% interest makes it well worth it.
The other nice thing about these accounts is that you can get $20 to start your Netspend account just by using my referral link. Once you deposit $40 into your Netspend account, you snag yourself a $20 bonus and I get myself a $20 bonus. From there, you can then refer your spouse to Netspend with your own referral code. That way, you’ll snag another additional $20 referral bonus and your spouse will snag a $20 referral bonus. Altogether, that’s $60 in referral bonuses you can make with pretty minimal work. And you still end up with a savings account earning 5% guaranteed interest.
If that doesn’t interest you, then I’d at least say that everyone should open up two Insight cards and put away $10,000 or so as their emergency fund. There’s no reason your emergency fund shouldn’t earn 5% interest.
For more information, be sure to read my two in-depth posts about these savings accounts. I’d recommend reading them both together so that you can understand how they work.
5. Investment Accounts
There are some people out there who argue that you should consider investing your emergency fund in a pretty low-risk allocation such as a 50% stock/bond mix. An allocation like this is estimated to return about 5% or so over the long term.
Personally, I don’t think that anyone should invest their emergency fund like this. Why would you take on any stock market risk in your emergency fund when you can already get a 5% guaranteed return on your emergency fund in a super high-yield savings account? It makes no sense.
My guess is that most people who recommend investing your emergency fund either don’t know that 5% interest savings accounts exist or feel that they’re somehow a trick. Personally, I’d think investing your emergency fund is more work than just opening up a super high-yield savings account. And if you’re going to get around 5% interest by investing your emergency fund, it’d be foolish to take on the risk of loss when there are already ways to get 5% interest risk-free.
My Emergency Fund System
I’m on a bit of a mission to get people to realize that their emergency fund can actually return significant money in an FDIC-insured savings accounts. Most people don’t need to worry about having too much cash in their emergency fund because you should be earning 5% interest on most, if not all of it.
I personally put my emergency fund in three places:
- Super High-Yield Savings Account with Netspend and Insight
- Online High-Yield Savings Account with Ally Bank
- Checking Account with my regular brick and mortar bank
The bulk of it is kept in my super high-yield savings accounts, where I earn 5% guaranteed interest. I set up these accounts once and then I’ve never had to touch them again other than to withdraw the interest I earn each quarter. I haven’t been able to max out all of my super high-yield savings accounts just yet, but once I do, they’ll give me $750 of interest every year (right now I’m getting about $350 per year from my emergency fund based on how much I’ve put away). Couple that with my spouse’s super high-yield savings accounts and we’re looking at $1,500 of interest earned every year. To put that in perspective, we’d need $150,000 saved in a standard online savings account to earn that kind of interest!
The other nice benefit with these super high yield savings accounts is that they make me less tempted to use the money for non-emergencies. It basically puts a little bit of a barrier between myself and my money, so I’m only going to pull that money out when I really need it.
I then keep about $1,000 or so in my Ally Bank account, where I earn 1% interest. I like to have this here as a bit of a buffer in case I need the money really fast and don’t have time to get the money out of my 5% interest accounts.
The remainder of my emergency fund is a $500 buffer I keep in my regular checking account.
My emergency fund system has worked out pretty well so far and I’m happy that it’s earning a solid rate of return. The 5% interest is even more impressive since it’s risk-free. With that kind of return, I’m not too concerned about the negatives of holding too much money in cash. I basically get the best of both worlds. Peace of mind in having enough cash. And a rate of return that’s more than nominal.
Readers, where do you put your emergency fund? I’d love to hear what you’re doing with your emergency fund.