Where Should You Keep Your Emergency Fund?

In the last post, we talked about why it’s important to have an emergency fund and how big it should be.

But there’s a question we didn’t address: Where should you keep it?

When it comes to selecting a home for your this stash of cash, there’s a few important criteria we need to keep in mind:

• You need it to be separate from your spending money
• It has to be liquid (you need easy access to it)
• You want some sort of interest or return
• You want it to be safe, preferably insured

The Best Place For Your Money: An Online Savings Account

Having your money in a savings account instead of your regular checking provides a clear line of demarcation. This money over here is to pay my bills, this money over here is for a rainy day.

Yet despite the clear separation, you can initiate a transfer and it will happen in seconds. You always have easy access to your money.

In general, interest rates at banks suck. They’re about as low as they can possibly be. This has been true for over a decade with a very brief exception late in the 2010’s when they started to creep up before they came crashing back down in 2020.

Online banks have smaller overhead than traditional banks and tend to offer higher interest rates. At the time I’m writing this, Bank of America is offering 0.01% on their savings accounts. That’s pathetic. If you kept $10,000 in one of their savings accounts for a year, they’d pay you $1 in interest.

In contrast, Ally Bank offers 0.5%. This means over the course of a year, you’d make about $50 in interest on an account with $10,000 in it. Still not great, but much better than BoA.

My Favorite Bank

My favorite Bank is the one I just brought up: Ally Bank.

Ally has no monthly maintenance fees. There’s no minimum deposit. They don’t charge overdraft fees. Their just a good company to bank with.

I’ve been using Ally since 2013 and I’ve been very happy with them.

One cool feature they have is that you can divide up the money in your savings account into different “buckets” marked for different categories. So you could have one bucket for an emergency fund, one for home repair, and one for vacation savings all in the same account.

Alternative Locations

A Roth IRA

If you want to invest your money instead of letting your cash sit there losing purchasing power to inflation, you can put it in a Roth IRA.

A Roth IRA is a retirement account, and retirement accounts usually have penalties for taking money out before age 59 or 60. The trick with a Roth IRA is that you’re allowed to take your contributions (but not your earnings) out tax and penalty free.

There are a couple downsides to this approach.

The first is that there’s a $6,000 yearly contribution limit ($6,000 at the time of writing, it periodically goes up). This means that it will take a few years before you can invest enough to represent a solid emergency fund.

The other risk is the possibility of a “double whammy.” It’s possible that the market crashes just as you need to access your funds do to a personal emergency. This would force you to sell at a loss and would suck.

Investing The Simple Way

A HELOC

If you own a home, opening a home equity line of credit (HELOC) can serve as a kind of emergency fund.

A HELOC is different than a normal home equity loan. The home equity loan lets you take out a lump sum secured by the value of your home and works like a normal loan. The HELOC gives you the ability to borrow money if needed, but you don’t have to.

The downside of this approach is that you are taking out debt to cover an emergency, but it’s debt at a much lower interest rate than you’d get with a credit card.

This can be a good option for people who spend far less than they earn and are aggressively investing as they pursue early retirement. The idea would be that if you hit an emergency, you’d withdraw from your HELOC to pay for it, then temporarily divert the money you’ve been investing monthly to paying back what you borrowed.

You have to be very careful with these however. First of all, you need to make sure there is either no minimum withdrawal, or at least a very low one.

You also have to bear in mind that once the withdrawal period ends, the minimum payments basically double. This is because during the initial withdrawal period, your payments are interest only. During the repayment period, you have to start paying principal and interest so you can repay your loan.

BlockFi

BlockFi is a place where people invest in cryptocurrencies.

So why am I bringing it up in a discussion of emergency funds?

Because in addition to buying and selling crypto, you can hold “stablecoins” (GUSD) whose value is held steady at $1 and earn 7.5%.

On $10,000, a 7.% interest rate earns you $750 per year. Actually, it earns you $776.33, since you get paid interest monthly and that interest earns interest.

This is way higher than what you can get at a bank, even a high interest online bank.

How is BlockFi able to offer such a high rate? Well, they do what banks do. They pay you interest to hold your money and they lend it out at a higher rate. It’s just that they are able to lend to the crypto crowd at 10-12%, whereas banks are only able to charge their customers 3-4% right now.

The downside to BlockFi is that it’s not a bank. Banks are FDIC insured, meaning if they bank fails $250,000 of your money is protected by the federal government. So there’s basically no chance you’ll lose your emergency fund.

If BlockFi fails…well, I’m not sure exactly how it would play out, but I doubt it would be good for you.

Another downside to BlockFi is the $10 fee for taking money out.

So if you want great rates and are comfortable with the risk and fees, this is your answer.

My guess is that their rates will eventually come down though. It’s just hard to imagine it would be sustainable to offer 7.5% forever.

Final Thoughts

A savings account is just about the most boring financial instrument you can imagine. But it gets the job done.

My emergency fund is held in a savings account with Ally bank, and I’m glad it’s there for me if I ever need it.