Having at least six months of expenses provides financial stability, helps you avoid debt with high interest payments, and lowers stress levels. We have a full year of expenses put aside in liquid cash, and it lets me sleep well at night.
Emergency funds can actually have a better return on investment than what you see on a bank account. But that doesn’t mean I shouldn’t still maximize my interest earned, especially as cash is an asset class where you can increase your return without having to take on additional risk (if you stay FDIC-insured or equivalent).
Even though interest rates are low, if you can earn an incremental 1% more over years it becomes significant. I last shared my emergency fund breakdown in the 2nd quarter of 2011, and rates have stayed low since then. Here’s what the overall scene looks like today…
Rewards Checking Accounts
Usually through smaller credit unions with limited membership areas, these checking accounts pay a higher interest rate if you jump through some hoops each month. However, if you make a mistake you’ll forfeit virtually all your interest for that month, so it can be tricky. An example is Consumer’s Credit Union and their Free Rewards Checking account paying 4.09% APY interest on balances up to $10,000 if you make 12 debit card purchases + one billpay per month. The rate is even guaranteed at least through June 30, 2012. You can join with a $5 one-time fee, as noted on their online application.
Find a local rewards checking account by using the filters at the DepositAccounts database. I no longer have any money in any rewards checking account as the benefits are too low for the time and effort of jumping around, especially when I could just do some $250+ credit card bonuses for much more (non-taxable) easy money.
Long-Term CDs – Ally Bank
If you have a large cushion, it’s quite likely to just sit there for years or more. Therefore, I think it’s okay to put some of it in longer-term investments. With the Ally Bank certificates of deposit, you can still access your money as long as you pay a early withdrawal penalty of 60 days interest. That’s significantly less than at other banks. I have 5-year CDs paying 3% APY, but the current rate for new deposits is 1.60% APY for a 5-year CD (as of 10/25/13). I’ll show you below why this is still a competitive and flexible rate.
Let’s analyze a CD paying 1.74% APY with an early withdrawal penalty of the last 60 days of interest. Here’s how your actual annualized interest rate would fluctuate given your holding period.
After just 6 months, you’ll already be earning 1.15% even after the penalty. If you hold it a year and withdraw, you are already at 1.45% APY. Try to find any similar 6-month or 12-month term CD that beats those rates. Basically after just 6 months I have nothing to lose and a lot to gain, so I keep a sizable chunk here.
U.S. Savings Bonds
For inflation-linked Series I Savings Bonds, the total rate earned consists of a fixed rate and a variable rate that adjusts with inflation every 6 months. Series I bonds bought right now will earn 3.06% for the first six months, and then an unknown rate based on ongoing inflation after that. Even with zero inflation, it will still earn more than any 1-year bank CD… and I really don’t see zero inflation.
My older I-Bonds have been paying off, some of them have a higher fixed rate of about 1%. I was recently earning 4.6-5.6% a six month period. For 2012, the annual purchase limit for electronic U.S. savings bonds bought at TreasuryDirect is now $10,000 per series, per person. You can also get another $5,000 in paper bonds from your 2011 tax return refund using Form 8888.
Online Checking and Savings Accounts
The online savings account world has been a rather boring and dreary place. The classic Capital One 360 is now at 0.75% APY, and other banks are clustered around it. The only mildly exciting thing that has happened is TIAA-CREF has started TIAA Direct with an intro rate of 1.25% APY. But even they admit that’s a promo rate and it could drop any day. It appears far too difficult to separate yourself from the pack for long in this rate environment, otherwise somebody would do it. Alternatively, Everbank has their Yield Pledge Money Market and Interest Checking paying 1.10% APY guaranteed for the first 6 months for new accounts. Since it is fixed, that is better than any other 6-month CD rate out there.
Since I already have my CDs there, I’ve been happy waiting things out with Ally Bank for my daily banking convenience and emergency fund needs. Their Interest Checking currently pays 0.40%-0.75% APY and their Online Savings is at 0.85% APY (as of 11/12/13). I am going with Ally due to their checking features like no fees, ATM fee rebates everywhere (even at ripoff Las Vegas casinos), and free overdraft transfers from savings. This allows me to keep a minimal balance in checking and more in savings/CDs. Check out my Ally Bank Checking account review for an in-depth rundown.