The first major step on the Family Finance Road Map to free yourself from credit cards and adding to your debt is to build an Emergency Fund. But where to keep that emergency fund is this week's follower Ask Me Anything topic.
Every day, I get lots of great questions from followers across social media, in the Family Finance Moms closed Facebook group, via DMs on Instagram, and submitted to my Contact Me page. Some of these are questions I get in varying forms frequently and are worth sharing as a reply to help everyone. Each week, in the Ask Me Anything series, I'll be sharing an actual question, straight from one of you, and a fully researched and detailed reply.
This week's question comes from one of my Instagram followers and is about where to keep an emergency fund.
Can I use a short-term CD for growing my emergency fund?Click to Tweet
Before I can fully address this week's question, let's define a few of the financial terms that appear in the question. To understanding where to keep emergency funds, you first need to know what one is. Then, I will talk about what a short-term CD is and why that may not be the best place to grow your emergency fund.
What is an Emergency Fund?
Each year, the Federal Reserve Board publishes its report on the Economic Well-Being of US Households. One of the measures it surveys is a family's ability to deal with unexpected expenses. In the latest report, 4 in 10 households could not afford a $400 emergency expense. If faced with one, they would have to borrow, sell something or just not be able to pay it.
The good news? This number is improving. Over the last 5 years, the percentage of families who could cover a $400 emergency expense with cash has increased from 50% to 59%. But for those who can't, most turn to debt to cover it - making that emergency expense even more expensive.
No matter how organized you are, and how well you budget, there will always be unexpected expenses that pop-up... and when they do, they are usually enough to blow your budget. The average trip to the emergency room can cost over $1,200. According to AAA, the average car repair bill will run you $500-600. Home repairs? Most experts will guide you to set aside 1-3% of the total value of your home annually for maintenance and repairs. For a $300,000 home, that's $1,000-$3,000.
If you aren't creating sinking funds for each of these unexpected, emergency expense categories, an emergency fund can be your go-to source for having savings on hand when you need it most. Instead of keeping a credit card on hand for emergencies and paying costly interest charges monthly, you can self-finance your emergencies by saving money in a savings account you designate as your emergency fund.
How Much Should an Emergency Fund Be?
Given the magnitude of many unexpected, emergency expenses, when you are first starting out, you should aim to save at least $1,000 in your emergency fund at first. As you pay off your debts and have more breathing room in your budget, you should add to your emergency fund and aim to have at least 3-6 months living expenses saved, in the event you should ever lose your job, to give yourself time to search for a new one.
For a few more rules of thumb? Take a look at the average cost of the emergency expenses above. A trip to the ER averages $1,200. The average car repair bill will run you $500-600. Annual home maintenance and repairs will run you 1-3% of the value of your home. Look at the deductibles on your health, home and auto insurance. Is your emergency fund enough to cover those? And for more guidance, take a look at all these examples from my followers of how their emergency funds have bailed them, without resorting to credit cards, in all types of emergencies.
Where to Keep Emergency Fund?
So back to the original question:
Can I use a short-term CD for growing my emergency fund?
Your emergency fund needs to be accessible in the event of an emergency. Sure, for some emergencies, you may get billed 30-60 days after the fact, but for many others, you will likely need the money within 24-36 hours, if not immediately. You need repairs done or treatment now, and the deductible or co-pay may be due up front.
This doesn't mean you have to keep the money in cash under your mattress. Or that you can't earn interest on it. But you want it in a fully liquid and highly accessible account, like a savings account. Today, you can find online high yield savings accounts like Marcus by Goldman Sachs, Ally, American Express, HSBC and others all paying 2% interest annually or more vs. the average national rate of 0.10%. But they still work as liquid savings accounts. You can access your funds when you need them, at any time.
A CD, or certificate of deposit, can earn you a slightly higher annual interest rate. BUT to get it, you have to lock your money up until a fixed maturity date, typically ranging from 6 months to 2 years or more. The longer you are willing to wait, the higher the interest rate you can earn. This can definitely be a good option for short-term investing, or if you are saving for a specific purpose in the future, but it is not a good option for emergency funds... because you never know when an emergency will hit.
To learn more about the path you should follow to build a financial plan you and your family can live with, be sure to download a copy of the Family Finance Road Map here. It will walk you down the path of living day to day, and paycheck to paycheck, to planning your financial future into retirement and beyond!
If you have a question you'd like me to answer, feel free to Ask Me Anything anytime!
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