It may be one of the first lines on the checklist for healthy finances: Having an emergency savings account.
Can you cross it off? If so, that’s great.
But even those with a cash cushion tend to make a number of mistakes, experts say.
To start off, many people leave their hard-earned money with an ungenerous bank, said Allan Roth, founder of financial advisory firm Wealth Logic in Colorado Springs, Colorado.
It’s worth shopping around for a better offer. “It may not seem like much, but $100,000 earning 0.50% is $500 a year,” Roth said.
The average online savings account rate is currently 0.45%, while its just 0.13% with traditional brick-and-mortar banks and credit unions, said Ken Tumin, founder and editor of DepositAccounts.com. (You’ll just want to make sure any account you put your savings in is FDIC-insured, meaning up to $250,000 of your deposit is protected from loss.)
“To find the best place for your money, don’t limit yourself to just savings accounts,” Tumin added. “There are also money market accounts and checking accounts that are federally insured that can offer higher rates.”
Yet getting too greedy with returns can backfire. Most experts say you should not rely on money invested in the stock market as a form of emergency savings.
“One mistake is not keeping the emergency fund in a safe and liquid account,” Tumin said. “Stocks and stock funds may be liquid, but they could experience large declines in value when an emergency occurs and you need to access the funds.”
Since most experts agree that your emergency money shouldn’t be in the market, you’ll want to take some time to figure out the amount you need to set aside.
Salting away too much can cost you.
“Cash can be the riskiest asset class of all,” said Roth, referring to the problem of inflation. If prices go up 3% a year, he said, over a decade $10,000 essentially becomes worth only $5,500.
There’s no one-size-fits all advice for how many months of expenses should be sitting in your rainy day fund. Job security, experts say, is a big factor to consider.
“If you’re working for a risky start-up company, you may need more,” Roth said. “If you’re a tenured professor at a university or a federal employee, you may need less.”
When figuring out how much his clients should set aside, Alex Doll, a CFP and president of Anfield Wealth Management in Cleveland, creates a budget for them and separates their expenses into “wants” versus “needs.”
“The emergency savings account should be based on the ‘needs,’ meaning things that you absolutely have to pay, like mortgage, car payment, insurance and groceries,” Doll said. “Then, based on their job and income situation, I typically recommend they keep three to six months of that money in cash.”
