Where I Put Our Emergency Money
Is there such thing as saving too much money in an emergency fund? What’s the best place to keep the money you do save so it still earns you something while just sitting there?
There are lots of discussions on why an emergency fund is the foundation of personal finance. Before starting investing your money in the stock markets, you should have a safety net to protect your assets. As for how much is enough for an emergency fund, a commonly accepted standard is that you should have no less than three months’ worth of money to cover your daily expenses, including all your obligations such as mortgage, loan, and insurance, etc. The total amount then is your average monthly spending multiplied by number of months you need to go through the uncertain period.
Now back to the question: Can one save too much in an emergency fund? My answer to this question is: Yes, that’s possible. The problem isn’t really that one saves too much money, but rather the money treated specially as emergency fund could be too much. Since an emergency fund is the money that you set aside for unexpected events, the money should be held in places like bank checking account, savings account, CD, or short-term Treasury bills that are easily accessible. This means you can’t use your emergency fund to make long-term commitment such as investing in stock markets. Historically, however, stocks provide much higher return than other investment vehicles. Thus, one can risk of losing money by putting too much in short-term investments than letting the money participate in stock markets. In my opinion, 3-month is the minimum, 6-month is adequate, 12+-month isn’t really necessary.
That being said, like any other personal finance issues, how to create an emergency fund (or whether or not to create one) is very personal. There’s no formula to tell you how much is enough and it also depends on what you consider as an emergency. For us, the biggest worry is loss of jobs, but that’s hardly considered as a true emergency. If we lose our jobs today, there will still be foods on the table tomorrow. Our emergency money is to prepare for the situation in which it will take several months before we can find a new job.
In answering this week’s money question, here’s what I do with our emergency fund:
1. Checking account
I put around $5,000 in the Bank of America checking account that we can withdraw immediately. These money is used to cover our living expenses and the account is account is refurnished twice a month from our salaries. I couldn’t imagine any situation that requires thousands of dollars right away, thus it doesn’t make sense to have more than necessary in a checking account that earns nothing. If all the sudden I need to pay a big bill, I assume in most cases I can charge with my credit card. As long as I can pay with credit cards, I am not worried about the cash in the checking account.
2. Online savings account
After all monthly bills are paid off, any excessive fund will be shifted to high yield online savings banks (here’s how we set our savings on autopilot). Since my use of online banks is very simple, I don’t care too much the extra features. As long as the fund is FDIC insured, the bank supports ACH transfer and pays out nicely, I am willing to use it. There are many online banks now pay 5+% APY for your money. If you are looking for big names, Citibank (4.50% APY), HSBC (5.05% APY), ING Direct (4.50% APY, Affiliate link), GMAC Bank (5.10% APY), and Emigrant Direct (5.05% APY, Affiliate link) are possible choices. Some small players offer higher rates, such as Amtrust Direct ( 5.36% APY), UFB Direct (5.31% APY), and IGoBanking (5.30% APY) with low minimum deposit requirement, and they can also provide excellent customer service.
3. Treasury bills
This is my favorite for short-term investment that generates decent returns. Currently 4-week T-bill pays 4.924% APR, which is equivalent to 5.04% annual yield. However, since interests from T-bill investments are exempted from state and local income taxes, your actually yield will be higher (here’s a formula to calculate your equivalent yield). For example, for NJ residents, I will have to get more than 5.38% APY from a bank to beat the T-bill yield. From what I can see, there two drawbacks of investing in T-bill. First, T-bill rates change every week, so you don’t know in advance what you will get for your next investment (a couple of weeks ago you could earn 5.36% APY). Second, you money will be tied up for four weeks, but I think that’s a small price to pay for a better return (here’s how to invest in T-bills).
Several other bloggers have weighed in on this issue with their own opinions. You can find all the discussions by following this and this link. Ben also provided a nice summary that covers everything you want to know about emergency fund.
To get an idea on how much people think is appropriate for an emergency fund, I just created a new poll, How Much Is Your Emergency Fund?, that you can cast your vote from the right sidebar.
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