One of the essentials of successful finances is the emergency fund. Your emergency fund can provide a measure of protection and security from financial setbacks. When you have an emergency fund, you can draw on it when you need extra cash for a medical emergency, or when you need to partially offset a job loss. As you build your emergency fund, though, one of things you have to decide is where you will keep your money.

Here are some of the options for your emergency fund.

High-Yield Savings Account

The savings account is a tried and true way to save up your emergency fund. The best option is a high-yield savings account, since the yield you get with a brick and mortar account is going to be minuscule.

• Pros: As long as your money is in an institution insured by the FDIC, your capital is safe. You can usually access your money quickly. You can request an ATM card to help you access your money if need be.
• Cons: Your principal is safe, but the yield is still low. Even with a high-yield account, you are lucky if you get close to 1% APY. Additionally, if you can’t get an ATM card to access your account, it can take three to four days to get your money, slowing you down in an emergency.

CD Ladder

If you want to boost your yield a little bit, you can consider a CD ladder. With this method, you regularly access CDs as needed.

• Pros: You can get a higher overall yield with CDs, especially if you have them for a longer term. The money is semi-liquid, and it is protected if the bank or credit union you use is FDIC-insured.
• Cons: The money is only semi-liquid. If you really need it, you can withdraw it, but you might pay a penalty. In order to make a CD ladder work as an emergency fund, you need the money to mature more often than once a year. You’ll need to set up short-term CD ladder, and that can lead to lower yields.

Money Market Fund

If you want limited access to your money, and slightly better rates, a money market fund can be a good choice.

• Pros: Better yields are often offered by money market funds. Additionally, many funds, particularly bond funds, allow you to access your money with check, making it very convenient.
• Cons: A money market fund is not the same as a money market account. This means that your money is not FDIC-insured, and that you can lose some of your capital. Plus, there are usually limits on how often you can withdraw from your account each month.

Retirement Account

With the current economic situation, many consumers are turning to their retirement accounts for emergency money. If you have a Roth IRA, you can withdraw your contributions at any time, without penalty. With a 401(k), you will need to borrow against the account.

• Pros: The money in your retirement account has likely seen a much higher rate of return than cash products and cash-like products. In some cases, a portion of your capital might even be FDIC-insured. You can access the money fairly easily in most cases.
• Cons: There is no replacing the opportunity cost of taking money out of your retirement fund. Even if you repay the money, plus interest, you can’t overcome the fact that you missed out on the earnings you would have received had you left the money alone. Plus, if you don’t repay the money from your 401(k) or Traditional IRA, or if you dip into your Roth IRA earnings, you could be subject to early withdrawal penalties from the IRS.

Taxable Investment Account

Grow your money faster, and access when it’s needed, but be wary of possible losses.

• Pros: Earn a higher yield (in good markets) on your emergency fund. The bulk of my emergency fund is actually in a taxable investment account. Over time, it earns more than if I had it in even a high-yield savings account. Plus, I can access the money without worrying about early withdrawal penalties.
• Cons: Since it’s in an investment account, you can lose money. (You can offset some of the loss with a tax break.) Plus, it can take longer to access your money. You have to wait for the selling transaction to clear, and then you have to wait to transfer the money to your account. I have a small amount in a very liquid and accessible account that can tie me over until shares can be liquidated.

Where do you keep your emergency fund?

Photo via Wikimedia Commons