- Experts recommend having enough cash to cover at least six months' of expenses set aside.
- But with today's high inflation, those sums of money could be quickly losing value.
- With the Federal Reserve poised to raise rates in an effort to curb rising prices, it's a good time to revisit where you keep your emergency funds.
Finding a competitive interest rate on your emergency savings has become even more difficult amid record high inflation.
But there is good news. The Federal Reserve is expected to begin raising interest rates. When they do, that will kick up the interest you can earn on your cash.
Some accounts may be poised to see those increases first.
"The online savings accounts that are currently paying competitive yields are likely to be the ones that remain competitive as interest rates go up," said Greg McBride, chief financial analyst at Bankrate.com.
"You want to be where banks are already paying a premium to get your money," he said.
That's as government data on inflation continues to set records.
One key inflation measure watched by the Federal Reserve — the core Personal Consumption Expenditures Price Index — climbed 4.9% in December compared to the prior year in the fastest gain since September 1983. The Consumer Price Index for January shot up 7.5% compared to a year ago, another record gain dating back to February 1982.
Still, savers who want better interest rates on their cash should be patient.
It will take a while before the gap between the Federal Reserve's target 2% inflation rate and the interest rates on savings narrows.
Many online savings account rates are currently around 0.50%, according to Bankrate.
It will likely take longer than 2022 to close the gap between inflation and interest rates, McBride said.
As that transition happens, where you keep your emergency cash is going to be more important.
One advantage to online savings accounts is the flexibility they offer. Often, there are no minimum balances or restrictions on how long you need to have the money deposited, said Ken Tumin, founder and editor of Depositaccounts.com.
The rates offered by traditional brick-and-mortar banks are typically below the national average annual percentage yield of 0.05%.
When you're choosing an online savings account, it's important to do your due diligence to make sure it's a reputable financial institution. Also, be sure to check for Federal Deposit Insurance Corporation, or FDIC, coverage that will typically protect you for up to $250,000 in deposits.
Online savings accounts are typically the best place for sums of money you expect to need in one or two years, Tumin said. If your time frame is longer, you may be able to find a better return on your money elsewhere.
Series I savings bonds are getting a lot of attention now due to the interest rate they pay, which is currently an initial rate of 7.12%.
But there are limitations. Investors can only purchase up to $10,000 in I bonds per calendar year.
Moreover, you cannot cash the money out in the first year. And if you take your money out before five years, you will lose three months' worth of interest, McBride said.
The interest rate you earn is also subject to change every six months.
"It's good to supplement an emergency fund with I bonds, but you probably should not depend totally on an I bond for an emergency fund," Tumin said.
Certificates of deposit, or CDs, may offer higher interest rates on your savings. Generally, the longer the term, the better the interest rate. But that will require you to lock in your money for a defined period of time, which will not be advantageous as the Fed hikes interest rates.
"You don't want to be locked in at a time when rates are going up," McBride said. "That's like standing on the platform and watching the train go by."
Financial experts often tout the savings features of Roth individual retirement accounts, which allow you to invest post-tax money toward retirement and take out your contributions (not earnings) at any time without taxes or penalties.
But there are reasons emergency fund savers should be careful with those, too.
Often, you cannot put the sums of money you withdraw from a Roth IRA back in the account due to annual contribution limits.
"It's better just to leave retirement money for retirement and save for emergencies in a dedicated emergency savings account," McBride said.