How much of your emergency savings should be held in a savings account instead of the stock market or other account that has higher returns with various risks?—Mary
There's no question you should always have some money tucked away for emergencies.
Most financial advisers recommend keeping three to six months' worth of expenses for emergencies, but where's the best place to keep the money? Experts usually recommend a plain-vanilla savings account. But in a low interest environment, it can be frustrating to watch your money earning nothing. Here are some ways you can get a better return on your money without taking on too much risk.
Online savings accounts
If you're a super saver, you may not be satisfied with the .01% interest your local bank offers you. Instead, consider an FDIC-insured online bank, says Tammy Wener, a financial adviser from Illinois.
"They generally pay higher interest rates than local banks and can be easily linked to a checking account," Wener says.
For example, Ally Bank and Discover have online consumer accounts that have no transaction fees and no minimum balance, and offer approximately 1.2% in annual interest. This still may not seem like a large return, but having access to the money when you need it allows it to serve its purpose, according to Wener.
"While holding the funds in a savings account provides very limited growth potential, the peace of mind is more than worth it," Wener says.
Money Market Accounts
If you're open to performing savings transactions with a bank that may be a great distance away, a money market account may be another safe bet for your emergency fund. Money market accounts typically offer similar interest rates to online savings accounts, but some also come with additional liquidity by allowing you write checks from the account -- like Sallie Mae, which offers 1.30% APY, with no minimum balance or maintenance fees.
Because access to your funds in times of emergency is the primary function of emergency savings, Oklahoma-based certified financial adviser David Bize suggests keeping all of your money in a secure and liquid account.
"100% of emergency savings should be in checking, savings, money market account," Bize says. "These are 100% liquid and never decrease in value."
Mutual funds
If you're still worried about having such a large chunk of your money sitting in an account, there are times when it may be appropriate to consider a balanced mutual fund that could provide better opportunities for savings, says New York-based financial adviser Byrke Sestok.
In order to determine which fund to use, he recommends looking at how a fund performed during the Great Recession, one of the greatest stock market declines.
"If you could tolerate a loss of a similar percentage to your emergency fund that occurred in that period then you may have a good fund to use," he says.
Stock market dangers
In theory, you could keep part of your emergency savings in the stock market. However, Arizona-based financial adviser Dana Anspach notes that market declines often go hand-in-hand with layoffs and recessions.
"That means at exactly the time a big stock market decline occurs, you could be out of a job," she says. "If your money is invested in the market, which could mean it is worth 40-50% less at the time you need it most."
Investing your emergency savings in the stock market exposes it to risk, and makes it less accessible to you. For that reason, most advisers recommend keeping your emergency fund out of the market.
"Doesn’t put money in riskier investments until you have an adequate emergency fund tucked away somewhere safe and sound," Anspach says. "You want to know what your emergency fund will be worth should an emergency occur."