What investment options should I consider for my emergency fund?

Question

I have an emergency fund with 3 months of income saved up. It is currently in a money market earning less than 1%. This money is saved in case I lose my job or need to make a major repair on my home.

I would like to keep one month of income in the money market where its very safe and very liquid. I would like to move the remaining two months of income into an investment which pays a higher rate than my money market, has a relatively low risk, and can be sold/liquidated within a month. My intention is to have emergency funds available in the money market, but have longer term emergency savings earning a little more interest.

What options should I consider for this type of savings/investment? Traditionally CDs would be the recommendation, but the rates are abysmal.

Answer 1

While I don't disagree with the other answers as far as CD laddering goes (at least in principle), three months CDs are currently getting much lower rates than money market accounts, at least according to http://www.bankrate.com. A savings account is also more liquid than CDs.

Bonds are another option, and they can generally be liquidated quickly on the secondary market. However, they can go down in value if interest rates rise (actually this is true of CDs as well--there is a secondary market, though I believe only for brokerage CDs?).

Bottom line, A high yield savings account is likely your best best. As others noted, you should think of your emergency fund as savings, not investment.

Answer 2

Try and save up for another month's expenses in your emergency fund, but while you are doing so begin building what is called a ladder of CDs. Tomorrow is April 1, so open a three-month CD (yes, the rates are abysmal but better than money-market fund rates) with one month's emergency fund. Repeat the process on May 1. So now you have two CDs maturing on July 1 and August 1. On June 1, take whatever of that extra month's expense you have saved up and open yet another three-month CD. On July 1, re-invest the proceeds of the first CD into a new three-month CD. Ditto on August 1. On September 1, add the additional savings towards the additional month that you managed to make to the smaller CD to bring it closer to one month's expenses. Lather, rinse, repeat. You will, I hope, soon be in a state where you will have four months of expenses in your emergency fund: one month on hand for immediate use if needed right away, and three months of additional expenses becoming available in 30 days or less, between 30 and 60 days, and between 60 and 90 days.

Answer 3

The iron-clad rule of investing is that risk and return are directly related. It is impossible to get a higher return than you are getting without putting principal at risk. Your emergency fund should be in cash, preferably in government insured cash (like a savings account).

The best you could probably do is laddered 3-month CDs. That way, you could cash them out, one per month, as they mature.