Your Money

Where to stash emergency cash when the average savings account yields 0.11 percent

Here’s the 411 on how to kick-start your emergency fund
Here’s the 411 on how to kick-start your emergency fund

You don't get rewarded much by the market for being a good saver.

Sure, roughly 52 percent of Americans have more in their rainy day fund than they have in credit-card debt, according to a new survey from Bankrate. (That figure is based on an annual survey of 1,000 adults and has remained basically unchanged since 2011.)

But is that money working well in an emergency fund? The average savings account yields just 0.11 percent, which is far less than the rate of U.S. inflation.

Most financial advisors recommend you keep three to six months of expenses in an emergency fund. However, putting that substantial amount of cash in a traditional savings account is "losing money safely," said Nick Holeman, a certified financial planner with Betterment, an automated investing service.

Here are three ways you can boost the returns of your safety net fund while having the peace of mind that you can access the money when you need it:

High-yield online savings account

An online savings account that yields 1 percent or more is the safest option for an emergency fund and requires the least amount of effort. The account is insured by Federal Deposit Insurance Corporation for up to $250,000 per depositor per bank and you can access the funds within a day or two if necessary.

Setting up a high-yield online savings account may not be as easy as swinging by a friendly local bank branch, if one still exists, but it's nearly 10 times more interest on average. Banks are able to offer higher yielding accounts online because they come with less overhead expenses than traditional bank accounts.

More than a dozen financial institutions listed by Bankrate have savings and money market accounts with annual percentage yields of 1 percent or more. "It's a competitive market and a lot of banks on the top of the list tend to stay there," said Greg McBride, Bankrate's chief financial analyst.

Watch out for accounts that require a high minimum balance to avoid fees or offer an attractive introductory rate that will be cut a few months after you open the account. "It's a liquid account, so if you don't like the rate, you can always move to a better option," McBride said.

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Certificates of deposit

You can find rates higher than 1 percent in some certificates of deposit offered by banks. The trade-off with CDs is that you will lock up your savings for a set period of time. The terms of a CDs generally range from one month to five years. The longer the term, the more interest the CD will pay. And like savings accounts, CDs are also insured by the FDIC.

You can adjust to the lock-up periods of CDs by creating a "ladder," which is buying CDs at staggering maturities whether it's over several months or years.

Here's how a CD ladder would work: Let's say you have an emergency fund of $6,000. You put $2,000 in a six-month CD, $2,000 in a 12-month CD and $2,000 in 18-month CD. When the six-month CD matures, you invest the proceeds into an 18-month CD. You repeat the process as each CD matures. If interest rates rise, your laddering strategy will benefit from the higher rates.

When you use a CD ladder, it helps to have a little cash on hand in an online savings or money market account for unexpected expenses, said Howard Pressman, a CFP and partner at Egan, Berger & Weiner in Vienna, Virginia.

"With this strategy, there is some money immediately available in the money market account and then every six months as each CD renews providing liquidity. If money is needed before then, the CDs can be broken for a small penalty," Pressman said.

Does CD laddering sounds like too much work? You can always go long on a high-yield CD with your emergency fund and risk the penalty if you need the cash, said Allan Roth, a CFP and principal at Wealth Logic in Colorado Springs, Colorado.

For example, if you invested in a five-year CD earning 2 percent annually, and the penalty is six months of interest if you withdraw early, you only need to stay in the CD for at least a year to match the 1 percent of a high-yield savings account. After that, the 2 percent CD would earn more than the high-yield savings account.

A portfolio of stocks and bonds

You can ditch the inflation-lagging returns of bank accounts and CDs if you are willing to risk your emergency fund in the market.

Betterment recommends its clients put their emergency funds in a portfolio with between 30 percent and 40 percent in stocks and the rest in a diversified allocation of bonds because interest rates are so low, Holeman said.

If you follow this strategy, Betterment advises investing at least 30 percent more than the three to six months of expenses you would typically put in the emergency fund to hedge against market turmoil. So If your monthly expenses were $2,000, for example, and you wanted to save three months' worth of expenses for your emergency fund, you would need to invest $6,000 plus 30 percent more — another $1,800 — under Betterment's advice for a grand total of $7,800.

Many other financial advisors recommend similar approaches to emergency funds, such as investing in bond funds or using a Roth IRA, which allows you to withdraw contributions without tax penalties.

All these investing strategies involve taking more risk to earn better returns than liquid cash holdings. If your emergency fund is invested in a taxable account, you may also have to pay capital gains taxes when your fund's investments are liquidated to cover unforeseen expenses.

"Whatever you do, the most important thing is to have a safety net fund," Holeman said.

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