Emergency fund: Money market or high-yield savings?
Posted
Dec 11 2007, 12:50 PM
by
Karen Datko
Rating:
This post comes from partner blog Blueprint for Financial Prosperity.
What is the most important goal for an emergency fund? Capital preservation.
Your emergency fund is the foundation on which the rest of your personal-finance house is built. You should pour it and let it sit. Hopefully, you'll never have to touch it.
However, if you find yourself in a situation when you’ll need it, you want it to be available. That being said, a friend recently asked me whether a money market account or a high-yield savings account is better for an emergency fund.
Money market deposit accounts. These are basically savings accounts that give the bank greater discretion in how it can invest the money. In return for greater flexibility, the bank often will give you a higher interest rate, but may demand that you give at least seven days' notice before you make a withdrawal.
High-yield savings accounts. ING Direct, the high-yield savings account I believe has been around the longest, is offering 4.20% APY on online savings accounts. Comparatively, the highest APY of Bank of America’s Balance Rewards money market savings account is only 3.05% and that’s if you have $2.5 million in the account. BoA’s money market account isn’t the highest available, but it’s not even within spitting distance of ING’s 4.20% rate, and ING isn’t the highest rate available.
Money market mutual funds. A money market deposit account may be confused with a money market mutual fund, which is a different animal. A money market mutual fund is like any other mutual fund, with its own risk and return profile. You might be offered a higher rate of return, but you have no guarantee on your principal. If the fund's investments go south, your emergency fund could be depleted. I would not invest my emergency fund in anything that doesn’t guarantee my principal.
However, let’s say you wanted to take the risk. What are the returns? Vanguard’s Federal Money Market Fund, for example, has a yield of 4.60% and an expense ratio of 0.24%. If we ignore the expense ratio and look strictly at the yield, you’re talking 4.60% versus 4.20% at 100%-safe ING Direct. Half a percent isn’t worth it for me to open an account, transfer money, and take the risk.
How about this plan: Put part of your emergency fund in a high-yield savings account, and keep some reserve in a local bank so you can get to it ASAP. I don’t know why anyone would have funds in a money market deposit account given current high-yield interest rates. I also don’t know why anyone would put their emergency fund in a mutual fund, money market or otherwise, because of the risk. Even if it’s low, you could lose your principal.
Where do you put your emergency savings and why?
