Having an emergency fund that you can use when a real emergency should arise is a great idea. It also needs to be readily available, though, and you should not have to wait some time to get your money from it. Investing your emergency fund money will certainly make it even more valuable to you, but knowing just where to invest could a problem.
Knowing where to invest your emergency fund is complicated because the places where you can earn the highest interest rates are also those where there can be significant fees for early withdrawals. CD’s would be a good example.
An emergency fund needs to be largely liquid at all times just so that it is easily accessible in an emergency. The money needs to stay available so that it can be obtained within a couple of days – and possibly from more than one location. This is essential because some disasters, such as floods or earthquakes, could make access to a single bank or credit union building unavailable for a long time.
One writer, Dan Caplinger, at DailyFinance.com, says that people basically have two types of emergencies where emergency cash would be needed. The first one is the kind where an air conditioner or car breaks down. Naturally, you would not want to go long without either one, so money would be needed quickly to remedy the problem. Cash for this type of emergency would need to be readily accessible.
Another type of emergency is not so usually sudden or unexpected. This could be getting laid off from work, which often comes with a warning – possibly even weeks ahead of the event. This is where you need the larger amount of money, such as three to six month’s worth. Because of the advance warning, you would have time to move money around, so it does not need to be as liquid and can earn higher amounts of interest.
One place you can invest your emergency fund money rather safely is in I-Bonds. According to Zvi Bodie, in an article at PBS.org, I-Bonds enable you to get quick access to your cash, once the money has been in holding for a minimum of one year. Forfeiture of interest is limited to the last three months, if the bonds have been owned for less than five years. I-bonds are unique in that they earn interest equal to the initial fixed rate, plus the inflation rate, and deflation would not hurt it either. Interest is only paid on Federal taxes.
Money Market Funds
Money market funds is another place to put your emergency funds and have it earn interest – more than a savings account. This type of funds, says FINRA.org, enables your money to be highly liquid, and low risk. A problem, though, might be that they are not Federally insured.
Putting your emergency money into CD’s can be good, but if you have to withdraw the funds, you may lose the interest. You can “ladder” the money by putting equal amounts in six month CD’s, which would prevent you from losing all the interest if you need the cash. This would let you simply terminate a couple of CD’s if you do not need all of it. You can also reinvest the money when the CD expires and not pay taxes if it is rolled over.