One of the questions we get asked all the time is “where should I keep my emergency reserve (aka rainy day fund)?” or “What should I do with my extra cash?”
How Can I Get My Cash to “Work for me?”
If you haven’t already, I suggest setting an emergency reserve target. I generally recommend establishing a target of 3-6 months of living expenses. Although, like with all things related to personal finance, this is a highly individual decision and there is no right answer. There are many factors that can influence the target, including whether you are a single-income household or have highly variable income.
Before we move on, let’s establish up front that you’re already in good shape with regards to consumer debt (i.e. you don’t have significant credit card bills). That said, it bears mentioning that it is possible to build your emergency reserve and pay down high interest debt at the same time.
Where to keep your emergency reserve
High Yield Savings
My top recommendation for an emergency reserve (as of this writing) is a high-yield savings account. I always check bankrate.com for the best rates and as of April 2022, most banks are offering something like .60% – .70%. I prefer this account being separate from whichever bank you use for your checking account; I like the idea of it being ever so slightly harder to access these funds. Please do not be fooled by Bank of America (and some of the other big banks) whose “high yield” savings account actually only earns .05% interest. Don’t get me started on the inaccuracy of that claim!
In the past, CDs were a reasonable option for an emergency reserve. I, myself, used to have laddered CDs that came up each quarter, which I would then renew. Based on the current rates, CD rates are only fractionally higher than high yield savings accounts, so there’s no compelling reason to have your money “tied up” in a CD.
I bonds are all the rage the past few months. Rates are at 7.12% through April 2022 and will increase to an estimated 9.62% in May which is frankly jaw-dropping!
There are a few stipulations that you should be aware of:
- The rates reset every 6 months. The current rate is good on new I bonds purchased through April 2022.
- You can only buy $10,000 in I bonds per individual, per year. Depending on how much your emergency reserve target is, there’s a good chance you won’t be able to buy enough I bonds to hit that target, but you could always supplement with a regular high-yield savings account.
- Note: You can cash the bond in after 12 months. However, if you cash it in before it is five years old, you lose the last three months of interest. So it’s not quite as liquid as a traditional savings account.
Finally, in my opinion, it’s quite a bit of work! But if you’re up for the extra logistical steps required, you can buy bonds directly from the US Treasury.
Beyond the emergency reserve
Ok so you have a high yield savings account set up for your emergency reserve. Go you! What about any extra cash? How and where should you keep it?
Cash for short-term needs
Here’s where we start to talk about timing. Let’s take a step back and revisit your goals. What is that cash for? Are you earmarking it for something in the next, say, 3 years? (Think new car, big vacation or significant house project). If so, you should probably keep it in cash. The above ideas are still great options for anything you’ll need in the next 3 years. I know, I know, you really don’t want your cash “just” sitting there. I get it. However, this is where I get to put on my financial planner hat and remind you that investing in the stock market is inherently risky. If you invest excess cash (which you know you’ll need in the short term) and the market takes a nosedive, you could be in a real bind. In other words, you may have to sell for less than what you put in and/or less than you need.
I’d be remiss if I didn’t also mention FDIC insurance, and the importance of making sure your emergency reserve (and other cash) is fully insured. Federal limits provide FDIC insurance of up to $250,000 per individual, per institution. If you’re single, that’s pretty straightforward: $250,000 per bank. If you have more than $250,000, be sure to open an additional account at a different bank to make sure all your funds are insured.
If you’re married, you can have up to $500,000 per bank (assuming joint accounts). As above, if you’re keeping more than $500,000 cash, spread the money across banks to make sure you’re fully insured.
Cash that you don’t need within 3 years (long-term needs)
For cash that you don’t need in the next three years, you’ll definitely want to have a conversation with your financial advisor. Depending on your risk tolerance, goals, etc. it’s likely that investing anything “extra” makes good sense. If the cash is for very long-term goals (such as retirement), you could invest and there are a variety of account types that may or may not be available to you (such as a brokerage account or Roth IRA).
There are also options like paying down your mortgage or other debt (I’ve already assumed you don’t have significant consumer debt, such as credit card debt). Using a combination of several strategies mentioned above will help you make the best use of your cash. There are so many factors at play here, it’s impossible for me to give a general recommendation. The good news is, if you have your emergency reserve fully funded and still have extra cash, you have plenty of options!