An emergency fund is a crucial part of your financial life, and it’s important that you think about where you’re holding it to ensure you’re maximizing the effectiveness.
Emergency funds provide a shield for your financial life. When life throws something unexpected at you, your emergency fund allows you to take care of it without taking damaging actions such as expensive debt or liquidating assets. It protects you from the long-term impacts, and by storing it in the right account type you can make sure the money is there when you need it.
So let’s explore the criteria for good emergency fund accounts, and what the best options are.
What You Should Look for In an Emergency Fund Account
When considering an emergency fund account, you want it to be liquid and safe.
The whole point of an emergency fund is that it’s there when you need it, and in the amount that you expect. Liquidity is the ability to quickly convert the fund into usable cash. That basically means how quickly can you get the money to where it’s needed. Safety means that you can be confident that the money is not volatile, and you can be confident the value won’t go down.
So let’s look at some options for accounts, starting with those that are most highly recommended.
Recommended Account Types
The Best Emergency Fund Account Is a High Yield Savings Account
High-yield savings accounts allow your emergency fund to be in cash, while allowing for some growth.
Now this growth isn’t going to be earth-shattering (maybe a couple percent), but you know it’s only going in one direction (up!). This takes care of the safety piece as the value will never drop. As for liquidity, the money is already in cash. The only disadvantage is that often these accounts are held at a separate bank from the one that that you use for daily banking. But so long as you have healthy access to credit, the couple days to transfer the money to where you need it should be no problem.
High-yield savings accounts are a great way to have easy access, while allowing for some growth.
The Next Best Option is a Classic Savings Account
Normal savings accounts have the same access to funds, but with slight differences in liquidity and growth.
Because you can have a normal savings account at your daily bank, the access to funds can be almost instantaneous – all it takes is transferring between accounts. As for growth, this account will have have a very low interest rate, but still higher than a chequing account. That said, it still checks the box for safety as you know that balance won’t go down.
If you are concerned about the speed of getting your emergency fund to your chequing account, a classic savings account can house your emergency fund.
Non-Recommended Accounts
Don’t Hold Your Emergency Fund in a Registered Account
By holding your emergency fund in a registered account like a TFSA, you are wasting opportunity and potentially penalizing yourself if you need to withdraw.
Registered accounts have tax advantages for growth, and by holding your emergency cash there, you can’t use it for investments. As well, there are considerations for any withdrawal from a registered account. You don’t want to be penalizing yourself when you’re already dealing with an urgent expense.
And you should not be investing your emergency fund, as that violates the safety requirement. If the market turns down when you lose your job (which are often related), you could have less in your emergency fund than you planned.
Save your registered accounts for investments.
Don’t Hold Your Emergency Fund in a GIC
Guaranteed Investment Certificates (GICs) tie up your money for a specified amount of time in return for some interest.
Tying up your money violates the liquidity criteria for accounts. Now depending on the terms of the GIC, you may be able to withdraw the money early, but you may have to sacrifice the interest you earned. You want your emergency fund to be accessible and liquid, no questions ask.
GICs can be a great resource, but not for emergency funds.
Conclusion – The Best Emergency Fund Account
You want your emergency fund to be held in an account where the money is accessible, and won’t go down.
High-Yield Savings Accounts are the best option, but a classic savings account is a decent second option. Don’t store your emergency fund in a registered investment account as it violates the safety (and wastes opportunity). And don’t choose an account where it will be tied up like a GIC.
Hopefully you won’t need your emergency fund, but when you inevitably do, by applying the knowledge in this article you’ll minimize the damage the event causes.