There is some debate as to where an emergency fund should be kept. Checking account? Savings account? Sock drawer? Penny stocks? Should I just use my credit card for emergencies?
Well if you know me at all you know I’m not going to say use the credit card. What about the others? Well let’s think about the purpose of an emergency fund. It is money set aside for emergencies and emergencies only. If you are on Baby Step 1 it is $1000, and if you are on Baby Step 3 it is 3 to 6 months worth of expenses (or more if you aren’t comfortable with that).
You probably don’t want to go with the sock drawer for 6 months worth of expenses, but if you want to have a few dollars on hand I guess that’s ok. It isn’t going to be the best choice for any meaningful amount of money. If you get burglarized (an emergency) you probably don’t want him to get your emergency fund.
That leaves us with checking account, savings account, or the stock market. Stocks probably aren’t your best choice here, though if you wanted to go beyond 6 months and earmarked some stocks as emergency I wouldn’t yell too loudly. In general though, you don’t want to ever have to sell when you aren’t ready. When an emergency pops up is probably not going to be when you are looking to sell.
Now for my solution. I’m going to say right now that some people will disagree with me, but this is what I think. I like a tiered solution. For the first $1000 baby emergency fund, I keep it in my checking account. I know this might make it too easy to get to, but I like the convenience. If I need new tires or some other small (few hundred dollars) emergency I don’t want to have to work real hard to get what I need done. If you aren’t very disciplined, you may not want to do this.
The rest of the three to six months should be in a savings or money market account with the best interest rate you can find. The interest rate isn’t really that important, as right now you aren’t going to make much at all, but it is nice to have. If you have $15,000 just sitting there, you might as well at least get the few hundred dollars you can make from interest.
There are some interesting options if you aren’t very disciplined and are afraid of dipping into your emergency fund. I have a savings account with Fifth Third Bank that I can transfer money into online, but I can only get it out by going to the bank. This inconvenience could actually be what you need to keep you from using that money. If you find yourself paying for the pizza using with your emergency fund, this might be a good option for you. Ultimately it was too much of a hassle for me, so now everything is in my checking account. After we get out of debt the 3 – 6 month fund is going to be in an ING Direct savings account.
Let me know what you think. Do you have an emergency fund? If you do, where do you keep it? Do you have multiple accounts?