How Does An Increase In Interest Rates Affect Your Savings?
Here’s the billion dollar question: should the fact that interest rates are now low affect the size of your emergency fund?
In a word: no.
Interest rates shouldn’t be the primary factor driving your decision to fund an emergency reserve. Your primary goal is safety. Like a storm cellar in Kansas, your emergency fund is a way to escape when disaster strikes.
That said, when interest rates are low, you might need to grab some creativity.
How Do I Tweak Rates?
Let’s begin with how you DON’T tweak.
In the past year I’ve read about investing instead in bonds, real estate and gold. I’ve even read that emergency funds are ridiculous because you can just take out a loan if you keep good credit. Take out a loan? How will you pay that back if you have no income? Of course emergency funds are ridiculous. So is a toilet. Why wouldn’t you just go in the trash? On second thought, I’ll keep both my reserve and my urinal.
Here are some better methods to reach for higher rates without affecting your security:
1) Compare interest rates at banks. Choose best fixed term savings accounts or money markets available from trusted banks. If the bank offers mobile banking options, and you can freely remove cash, it doesn’t matter where the brick and mortar bank is located. Your cash reserve isn’t your daily expense account, so you won’t need access to funds often.
2) Find CDs to ladder. As a second tier, take a portion of your cash reserve and stagger CDs. Purchase a 3 month, 6 month, 9 month and 12 month CD, for example. CDs may be a great choice because a timed deposit often earns a higher return if you promise to lock your money away longer. Even though the 12 month CD pays a higher rate, don’t choose just one. If you need the money, you’ll have to break the CD, losing interest and incurring penalties. Instead, when the 3 mos. CD comes due, transfer it to a 12 month CD, then when the 6 mos. CD matures, do the same. If you don’t end up using the month, you’ll have four one year CDs, a portion of which matures every quarter.
How much money should you move to CDs? Imagine the biggest check you’d ever write in an emergency. Maybe $1,000? Double that amount to leave in your “first tier reserve” (savings account or money market). Stagger the rest in a collection of CDs.
3) Schedule quarterly reviews. Interest rates change often. Providers such as Birmingham Midshires change rates often to stay competitive. Especially in low interest rate environments, you should be vigilant of news that might help you gain a higher rate.
Don’t Abandon Your Bank Account!
The worst mistake you could make as interest rates plummet is to lower the amount of your emergency fund. Some assets ARE about returns, cash reserves aren’t. Your job is about returns. Your portfolio is about returns. Your emergency fund is only about safety. Because you have this net, you can aggressively pursue strategies to increase your income and flex your investment muscles.
Photo credit: HowardLake
Sign up for our Free 2 Guys Newsletter
Get our "too-hot-for-blogging" fresh off the press, highly sought after top secret financial planning information! (and a free report in the process)
We hate spam just as much as you