Emergency Fund Savings (and interest!)
The Emergency fund is always a hot topic because everyone wants one, but no one likes seeing the .01% interest rate earned in a basic savings account.
The important thing to remember is that your emergency fund is not there to earn interest. The second thing is that the amount you need in your emergency fund changes in different life stages. A single 20-something that does not own a home needs far less than a 30-something parent and homeowner. Your emergency fund also typically start going down as the kids get older, your investments increase, and your mortgage/debts get paid down and eventually paid off.
It is a good idea to sit down and determine how much you need once a year. If your fund as too much put some in investments and earn more! If it has too little get more into that fund ASAP. Conventional wisdom says you should have 3-6 months expenses in this fund. The actual amount will vary based on your situation.
While interest is not a priority in an emergency fund, there is an interesting way to earn a little bit more interest. This method also gives yourself a deterrent that will make you ask: Is this really an emergency? Do I really need this money NOW?
This method is called laddering CD's.
You take your emergency fund and divide by 5 and open 5 separate CD's at your local bank or credit union (generally credit unions will have higher rates). You will want to open these five CD's on the same day and open 1,2,3,4, and 5 year CD's. The representative will likely inform you of a special rate on the 18-month CD (or some other odd number). Avoid this and stick with exact year CD's so that all your CD's renew on the same day every year.
When your 1-year CD matures renew the CD and reinvest the interest into a 5 year CD and repeat with every CD as it matures. Eventually you will have five 5-year CD's, allowing you to earn the higher 5-year rate, and giving you access penalty-free to 20% of your emergency once a year. Want to add a caption to this image? Click the Settings icon.
With a CD you can withdraw the funds early with a penalty (which is usually the interest you earned capped at 1 year's interest). This is ideal because the small fee will make you think twice about whether you really should be spending the money, but also does not cause you to lose the original investment (confirm this with your financial institution).
The interest rate you will earn does not appear to be much but it is surprising just how much your emergency fund will earn over time. Go to the below link to calculate how the interest should accrue for you. Remember the primary goal is preserving your fund with a bonus of some interest, so do not compare the interest to the expected earnings in your retirement account!
Contact me if you have any questions about developing an emergency fund, whether to keep an emergency fund or pay down debt, or other questions in the simple, complicated world of finance.