Why cash is the be-all and end-all for emergency funds and short-term savings
Articles about emergency funds may have put you to sleep as little as a year ago. At this point, you would have been lucky to find a high-yield savings account with a 1-2% payout.
However, as interest rates rise, investing in cash can yield substantial returns and result in some of the highest interest payments in decades. This is the perfect time to lay out why building an emergency fund is so important in an environment of high and low interest rates.
Where to keep your emergency cash
An emergency fund is a cash cushion for about three to six months of living expenses. If your job is unstable, a family member has significant health problems, or you are solely responsible for all of your bills, you should aim for even higher amounts. It’s not uncommon to see emergency funds Cover the expenses of a year. With this additional cash buffer, you protect your accumulated wealth so that no situation can jeopardize it and bring your financial world down.
However, simply keeping your money in a checking account won’t do you much good, and a regular savings account isn’t much better either. According to the Federal Deposit Insurance Corp. the nationwide average annual rate of return (APY) on savings accounts was a meager 0.39% in April 2023.
Try to put your money in a high-yielding savings account that offers FDIC insurance up to the $250,000 limit. Some online savings accounts pay interest rates of up to 4.75% APR. Banks like Ally, CIT Bank and SoFi offer some of the best interest rates. American Express High Yield Savings and Barclays Online Savings Account are extremely competitive. Be sure to check the minimum deposit required, the current account balance and whether there are any current account maintenance or other fees. These accounts may also have limits on the number of monthly transfers or withdrawals. However, if this is your emergency fund, don’t touch it often.
A deposit slip is another option. CDs can be a good choice for earning even higher interest rates than online savings accounts if you’re willing to invest in a long-term CD. CDs are savings tools that ‘lock’ your money for a set period of time – from three months to five years. During this time, your cash will earn interest at a fixed rate. The longer the term chosen, the higher the effective annual interest rate. For example, CDs with a maturity of six months are currently offering up to 5.0%, and CDs with a maturity of two years are even more attractive, paying around 5.20%.
While the prospect of making more money is attractive, owning CDs also has downsides. You cannot deposit and withdraw money with CDs. If you cancel your CD before the due date, you will be penalized in the form of a reduced interest payment. The penalty can range from three months’ loss of interest to a much more painful year’s loss of interest. As such, CDs are better for people who don’t need access to that money and have cash accumulated in a high-yield savings account that they can easily use for emergencies.
Saving is also important for short-term goals
Savings for goals with a time horizon of 1-3 years should not be invested in the stock market. This applies to home purchases, car purchases and more. But of course, the same rules still apply to high-yield savings accounts and CDs.
Client case: why you need to save as well as invest
A potential client – let’s call her Jane – contacted me last week about Francis Financial’s hiring as a money manager and told me that she is very concerned about the losses she has suffered on her portfolio in 2022. She explained that her portfolio had fallen in value so badly that she wasn’t sure how she would ever recover and just lost her job at a big tech company.
After talking to Jane for half an hour, I learned that she is, and has been, a role model for retirement planning She maxes out her 401(k) per year. She also worked for another tech company years ago and was able to save into their retirement plan and turn it into an IRA. Between her 401(k) and IRA rating, Jane has a nest egg of over $455,000.
Over the years, Jane saved part of her bonus and invested that money in a taxable brokerage account. Her portfolio was very aggressive as she wanted to increase yield so she could buy a house sooner. Unfortunately, Jane had terrible timing. The taxable brokerage account that was earmarked for the purchase of her dream home was worth over $255,000 at the end of 2021 and is now just $185,000.
Understandably, Jane is upset, but her situation could have been avoided as she was unprepared for the unexpected. Jane should have put her down payment savings into a high yield account or CD. Now she is forced to sell her portfolio after her shares suffered badly. Stocks almost always outperform cash, but not in a down market.
Withdrawing money from the pension scheme is also a “no-go” option. Since Jane is not yet 59½ years old, she would have to pay taxes and penalties on any money she withdraws.
Even if Jane puts off buying a home, she still has to draw on her taxable portfolio because she doesn’t have an emergency fund. But unfortunately, she was so focused on saving money for retirement and making big investments that she forgot to plan for today.
Hacks to build a saving habit
While it may seem daunting, by setting a goal and planning, you can save in a way that benefits your cash flow.
Diversity Woman, a publication that empowers women of all backgrounds, shares that even saving 5-10% of your salary can result in a well-stocked emergency fund and you’ll be well on your way to building your financial safety net in no time.
The easiest way to achieve this goal is to automatically allocate a portion of your salary to your emergency or short-term savings fund. Your emergency fund and short-term savings should be used for something other than your everyday checking or savings account. Instead, set up a separate space for those savings.
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Studies have shown that naming the account “emergency fund” or after the name of your goal, e.g. B. “home fund” also helps to motivate savers to increase the amount and frequency of their deposits. Better yet, be specific. For example, name your savings account 2027 Hamptons Dream Home Fund. Fewer people will put money into what is called a fund for non-goal related reasons, so those monies can grow over time.
By naming your bank account to match your goal triggers, you can better visualize achieving your goal, helping you stick to your savings plan.
Record your goals and calculate how much you need to set aside each month to reach them. For most savers, your goals are more achievable than you initially thought.
Be sure to consult a financial advisor when you know that advice and responsibility will help you. This is especially true if you have multiple goals that you want to coordinate together. A certified financial planner can help you design an action plan to achieve each of these goals within the timeframe you set.
– By Stacy Francis, Certified Financial Planner and President and CEO of Francis Financial in New York City. She is also a member of CNBC Financial Advisor Council.
https://www.cnbc.com/2023/05/22/op-ed-why-cash-is-king-for-emergency-funds-and-short-term-savings.html Why cash is the be-all and end-all for emergency funds and short-term savings