When you start saving money, one of the first steps is to set cash aside for emergencies. Typically, you want the equivalent of three to six months of expenses socked away, such that in the event of sudden job loss or unexpected medical bills, you can pull from your emergency fund instead of relying heavily on your credit card. Whether you have closer to three months of expenses saved or closer to six depends a lot on your current situation. If you have dependents or a volatile job, you may want to have a more robust emergency fund.
The popularity of an emergency fund is pretty self-explanatory. Your first financial line of defense is having cash on hand. It’s what empowers you to leave a terrible job or living situation, enables you to pay an unexpected tax bill or allows you to spontaneously fly to a relative in need.
However, the biggest argument against the emergency fund is that leaving cash sitting in the bank means it isn’t growing. Pro-risk investors might argue that leaving a substantial sum of cash (between $5,000 and $15,000, say) in an account with absolutely no returns means leaving money on the table. To that point, if you leave $15,000 in an investment account with a 7% return, the next year it would be $16,050. The year after that it would be $17,173.50, and so on. To put this in perspective, your money in your current savings account is likely accruing about .01% interest. That means if you have $15,000 in there, next year you’ll have $15,001.50.
So how do you make money off your emergency fund? Or rather, how do you keep your cash savings in a safe, easy-to-access place without missing out on the returns you could be raking in with investments? The compromise is to put your emergency savings into a high-yield savings account. A high yield-savings account is still significantly less volatile than an investment account. You have the benefit of compounding interest on your savings, but forgo a lot of the risk associated with longer-term investments such as mutual funds.
Unfortunately, we’re not exactly in the golden age of high-interest savings accounts. You are no longer going to find banks that will pay out more than 1% interest, whereas previous decades have seen much more favorable interest rates. Nonetheless, a 1% return is still a significant amount more annual earnings than a .01% return.
If you have a substantial emergency fund, and are looking for some return on it, a high-yield savings account is definitely worth considering. Here are some things to look out for while selecting an account:
1. Does the bank require a certain deposit upfront? You’ll want to confirm if there’s a minimum amount you can have in your account, and if you’ll be charged if your balance dips below that amount.