Having a 3-6 month Emergency fund is one of the best financial moves to makes. Some people even have a 1-2 year Emergency fund which I think is overkill, but to each his own and everyone has their own reasonings and unique circumstances.
I have been growing my emergency fund for a while in my regular savings account, but finally decided to pull the trigger and move to a high interest/ high yield savings account 3 months ago. I went with citizen access which has a 2.35% APY interest rate. The $10K I have in there earns me $20 a month and the interest compounds daily. I also love their customer service and there is no cap on the interest earnings.
But of course as soon as I went about gloating to my wife about how smart I was to open this account, I browsed online and found that there is now a 2.5% APPY high interest rate saving account with EBSB Direct and CITI bank also has a great one with 2.45% APY. I also found this great website doctorofcredit.com which does a great job of comparing and contrasting some of the highest interest savings account and CD’s.
High Yield/High Interest Rate Saving Accounts
So how does a high yield savings account work anyway? These banks, which are mostly online banks, are able to offer a higher interest rate because there are no branches to maintain, no tellers to pay for, no branch managers or janitorial staff. These banks sometimes raise interest rates on their high yield savings account to attract people and bring in more money. They then lower their interest rates when their needs change.
Most brick and mortar banks have tons of overhead expenses as mentioned above. These costs are partially shouldered by the patrons of brick and mortar banks in the form of lower interest rates.
Banks also change their rates based on the economy. For example in 1981 banks were offing interest rates on CD’s as high as 16% because the FED had to increased interest rates that much to combat inflation. If high yield savings accounts were out back then the interest rates would have been at similar levels, but notice how the interest rates just kept up with inflation and preserved the initial investments and purchasing power. This formula remains to this day.
Some of the other options available to place your emergency funds include money market accounts (MMAs) and Certificates of Deposits (CDs).
Money Market Account (MMA)
Money market accounts are similar to high interest rate account with some exception and one of them being how they invest your deposits. MMA fund managers receive compensation for lending funds to entities that need to fulfill their short-term debt obligations. This compensation is typically in the form of variable interest rates determined by the current interest rate of the economy. The money market yield will be lower than the yield on stocks and bonds but generally higher than the interest rates on standard and high interest saving accounts. Examples of securities that money market funds invest in include Treasury bills (T-bills), commercial paper, municipal notes, short-term asset-backed securities, Eurodollar deposits, and repurchase agreements.
Certificates of Deposits (CDs)
CDs generally offer higher rates than high yield savings accounts and MMA’s. It’s one of the best places to park your money if you can keep your savings in the bank for six months or longer. You may have to pay a penalty if you take your money out early though.
Typical CD term lengths range from three months to five years. In most cases the longer the terms, the higher the interest rate. With current interest rates on the rise, locking in a longer rate may seem less attractive, but if you’re risk averse and looking for a place to stockpile large sums of cash (those with 1-2 year emergency funds) opening a CD ladder may be right for you. You could for example open up CD’s with terms of 1, 2 ,3, 4 and 5 years. You could put more cash in the shorter terms so that you can reap the benefits of the expected interest rate hikes of 2019 and lock in the higher rates once the rates increase. It’s also somewhat similar to a market timing strategy because you don’t know what the highest 5 year term will be, but that would be the best bang for your buck. You could also just do a 1, 2 and 3 year terms if you like as well or just put the cash in the highest 5 year term you can find if you think the interest rate won’t go higher any time soon.
It is very important to read the fine print when signing up for these high yield savings account and MMAs because there are some wolves in sheep clothing out there. Some of the high yield savings accounts have caps. Meaning they only give the high 2-3% interest rates up to a few thousand dollars and then every dollar over the cap will only get 0.1% interest rate.
Some high yield savings accounts and MMAs also have different deposits limits in order to obtain the high interest rate. Like Citizen access for example. They require a $5K balance before you can start receiving their 2.35% interest rate on their high yield savings account.
To make matters even more confusing some high yield savings account rates are even higher than MMA rates and you’ll even see accounts listed as High yield savings/MMA. I think they do this to make themselves more marketable, but the only difference between the two is what they do with your money. When you put money in a savings account, the bank is limited to making loans with that cash. If you put it in a money market account, however, the bank can actually put it into low-risk investments such as certificates of deposit or government securities. MMA’s and high yield savings accounts may be the safer long term bet if ease of access to your money is important to you, which is the reason for an emergency fund in the first place. The icing on the cake is the MMA because the investments are more linked to relatively safe securities and they are less likely to draw you in with a promotional high interest rates for a couple of years and then slam you back down to reality when their needs change. Otherwise certificates of deposits (CDs) is the way to go.
In conclusion you really have to do your research when signing up for these accounts to both make sure you are getting the best rate and to make sure you are comfortable with the stipulations they will impose on you, because you are guaranteed to have stipulations. You just have to determine which situations and stipulations matches your needs best.