Savings accounts don't seem to generate much interest. What other options do I have for my emergency fund?
Opinions vary but I've always thought that an "emergency fund" is just that... for emergencies... NOT investment.
While it "hurts" not to have your emergency money making more money... its MORE IMPORTANT to have quick access to it.
As long as the interest rate keeps up with the rate of inflation leave it alone. Fill up your emergency fund with 3-6 mos salary and then INVEST your money beyond that however you see fit.
Dave Ramsey's "Financial Peace University" is a very good audiobook and I would recommend it to anyone asking questions such as this one.
Consider also setting up a CD ladder. CD rates are often better than savings account rates.
You have a 12-month CD that you purchase in January with a twelfth of your money, then another small one in February, then another in March.... then, when January comes around again, you a little more money to the first CD, and the ladder is complete.
The idea is that you have more access to your money than one big CD, since you'll always have a CD maturing next month that you can get to in case of an emergency, and you can get better rates on a 1-year CD than on something else (with less risk of being locked into a bad interest rate). And you'll be less tempted to tap it all at once to buy some fancy car or what-not because you can't get at it all at once (without a penalty). And in a major emergency, losing a few percent of your interest for early withdrawals is likely the least of your problems.
Actually there has been lots of talk around using a TFSA (Tax Free Savings Account) in Canada for just that purpose. A TFSA allows you:
- $5000 contribution limit per year with carry forward for unused balance
- Flexibility to withdraw funds at any time
- Income is tax sheltered
This blog makes some good points about exactly that:
The bestest thing about the TFSA is its flexibility. You can take money out of your TFSA at any time for any purpose, without losing the contribution room, which makes this account the number one choice for socking away an emergency fund. So even if you take money out in one year, you can put it back the next, without affecting that year’s $5,000 contribution limit.
I don't know Canada very well, but can offer some general points when considering where to park your emergency fund.
Savings rates are currently low, but then so is inflation. Always bear in mind that inflation decreases the value of your money, so if you're getting 4% interest and inflation is 2%, you're making 2% gross in real terms. If you're getting 2% and inflation is close to zero, you're actually earning a similar amount, it's just the numbers are going up more slowly.
Obviously when and how much tax you pay affects the actual return, it's just worth bearing in mind that low interest and low inflation are actually not that bad a savings environment as they first appear.
For an emergency fund the key thing is ease of access, consider keeping some portion of your savings in an instant access account for those emergencies that happen when the banks are closed.
In the UK there are various tax-free savings options, I'm guessing Canada has a few too, if so you should explore those options. While these may not have attractive headline rates, you don't pay tax on the interest, this can make them much more competitive (4% tax free is the same as 5% gross if you would have to pay tax at 20%). Normally tax free investments have caps so once you've invested a set amount you can't add anymore. This may be a consideration if you regularly dip into your emergency fund as you might not easily be able to build it up again.
My approach is to have about 90% of my "rainy day" fund in easily accessible but tax free savings. This discourages me from spending it unless I really need to. I then keep a slush fund sufficient to cover every day disasters (boiler packing up, needing a hire car for a week etc) in instant access accounts .
Since this post was written high-yield bank accounts interest rates have dropped significantly. High-yield, low-risk options are hard to find right now. Something like a Vanguard (or similar) bond fund might be an alternative to consider.
High-interest checking / savings accounts are often a better choice than CDs today for three reasons.
At the time this question was asked, CDs were probably a better answer as rates were much higher. Since CD rates have plummeted in recent years, and because a CD is only semi-liquid, i.e., even if you ladder CDs, an early withdrawal fee often means foregoing the interest on that particular CD which you withdrew.
1.) On the other hand, high-interest checking and/or savings accounts are very viable options these days. There are several options available that earn ~1%+ APY.
It's not quite that simple, and there are a few gotchas:
- some require a minimum balance
- some have tiered interest rates, for example, your first $2.5k receives a low APR while every penny beyond receives the high rate
- most have balance caps ~$10k–25k
- some require a certain number of transactions per month (while the first three are low / no maintenance to workaround, this one could be a pain)
If you run into the balance cap problem, of course nothing is stopping you from having multiple accounts across different banks.
2.) The high-interest bank accounts are fully
liquid able to be liquidated at anytime (without foregoing interest).
3.) A minor benefit is that the high-yield savings account is low maintenance whereas CD laddering is pretty hands on and may require physical trips to your bank. (If you know of a way to automate the process more, please comment or edit.)
If this is truly your emergency fund, then you should keep the money safe. Unfortunately interest rates are very low right now and there is not much you can do about that. However, ask your investment advisor for a CDIC insured high interest account, such as these:
- 0.50% RBC Investment Savings Account (Royal Bank)
- 0.55% Altamira High Interest Cashperformer (National Bank)
- 0.65% Dundee Investment Savings (Scotiabank)
- 0.70% Manulife Investment Savings Account (Manulife Bank)
- 0.70% Renaissance High Interest Savings Account (CIBC)
- 0.75% B2B High Interest Investment Account (Laurentian)
I use an offset mortgage. (No interest is paid, but the amount in the savings account is subtracted from the outstanding mortgage amount before interest is calculated, so the mortgage is paid off faster by the interest amount saved).
The money is instantly accessible and there is no tax as the benefit is reduced/saved interest.
However, the mortgage rate is slightly higher, so it works best if your emergency funds are a reasonably large proportion of the mortgage amount outstanding.
What worked out well for me is a Capital One High Yield Savings Account, which came with a lower interest rate than most online accounts but higher than a brick & mortar bank. Also, since Capital One has Banking locations now, I can use the ATM card that came with this account to pull out the emergency money if I need it in a pinch at a place that doesn't accept checks.
Just use a savings account and don't worry too much about the rate of interest. It won't be much, no matter where you put it, so optimize for convenience.
You will lag inflation, but that's okay. It's an emergency fund. You just need the money to be there when you need it.
There is no better option. Anything that might generate a higher return will have risk and/or not be liquid. Either of those things is bad for your emergency fund.
I was asking myself the exact same thing and I have come to the conclusion that most of your money should be invested in index ETFs and maybe some bond ETFs as well.
If inflation is about 2% and the interest you make in a savings account is less than 1% then you're actually losing money in a savings account.
Keep a few thousand bucks in your savings account and the majority invested and working for you.