You should maintain an emergency fund equivalent to three to six months’ worth of living expenses. This financial safety net ensures preparedness for unforeseen expenses, shielding you from resorting to debt or experiencing financial strain while attempting to cover unexpected costs.
Nonetheless, accumulating a substantial emergency fund can raise the question of whether you should consider investing it to generate better returns. Certificates of deposit (CDs) often offer superior returns compared to regular savings accounts, and they are FDIC-insured, which might make placing your emergency savings into a CD appear strategic. But is it truly a wise choice?
Does a CD suit your emergency savings?
The fundamental issue with stashing your money into a CD lies in the fact that CDs typically necessitate locking your funds away for a predetermined period. Although there are some “liquid” CDs that do not impose penalties for early withdrawals, they are less common and generally offer less favorable rates. In most cases, even short-term CDs have minimum terms that extend over several months, especially if you seek competitive rates.
The crux of the matter is that emergencies are unpredictable. You don’t want to tie up your cash in a 3-month or 6-month CD only to face a substantial unexpected expense in a matter of weeks. This could leave you with the undesirable choice of either accumulating debt to cover the cost of prematurely withdrawing your funds from the CD or incurring hefty penalties that diminish your available amount.
Your emergency savings is not an investment.
The reality is that your emergency savings should not be treated as an investment. Its purpose is to stand ready for you when needed, ensuring you can access it without worrying about incurring additional costs during a financial crisis.
There is no harm in exploring various savings accounts to identify the one offering the most competitive rates for your emergency savings. However, it is crucial not to take actions that compromise its liquidity or render it challenging to withdraw funds when required.
Given that CDs tie up your capital, the prospect of risking substantial losses due to unplanned early withdrawals to achieve slightly better rates than those offered by a savings account is unwarranted. Furthermore, it is unwise to consider placing your emergency fund into riskier investments, such as a brokerage account for purchasing stocks.
Remember, the point of an emergency fund is to protect yourself against unexpected financial setbacks. Keeping your fund in a secure savings account is recommended to ensure it’s readily available when you need it the most. Exploring alternative avenues for investment to secure generous returns while preserving the accessibility of your emergency fund is beneficial.