I remember having a savings account as a kid, and through most of the 1980’s had an interest rate over 5%. Today, with interest rates so low, savings accounts, especially bricks and mortar ones, are an absolute joke. We opened two custodial savings accounts for Loudboy and BirdsNest about a month ago to teach them basic personal finance at our normal bank. BirdsNest came in with me and got to meet the bank employee and ask questions. The interest rate on these accounts was 0.03%. No, I didn’t misplace the decimal. Not 3%, not 0.3% but 0.03%, or might as well be zero or equivalent to hiding it in my mattress. Basically, by putting money in the account, I’m providing negative value after inflation. For our purposes, it still serves a purpose though.
Our primary reason for even having a savings account is for risk protection should we need short-term cash for something. We want quick access in liquid funds, and savings accounts, even on-line ones, provides this features. We have a few different levels of savings from very liquid to moderately liquid as follows:
- $500 in cash at home in a lock box, in $20 bills or smaller. If the shit hits the fan (SHTF), I’ve got small bills in case change can’t be made and $500 can pay for groceries, gas and other incidentals in the days following an electrical outage or short term emergency situation.
- A varying amount of savings in our bricks and mortar bank that you see pays next to nothing, typically $1,000 to $3,000. Basic unaccounted paycheck overflow that buffers larger regular expenses that hit at less frequent intervals. Think tires or home owner association fees.
- Roughly three months of living expenses in an online account (Capital One 360 is who we use though others may have slightly higher interest rates or different benefits you may enjoy). It currently pays around 0.75% interest, which is a far cry from my 5% as a youth, but is significantly better than 0.0X%. We can add different accounts beneath the main umbrella, and besides our “Emergency Fund” account, we also have a “Car Fund” and will be opening up a “Vacation Fund” this year to save for future larger vacations. These funds can get transferred to our local bricks and mortar checking account, but often takes two business days, so is less liquid than the local account.
If the goal is liquidity, and for emergencies it doesn’t matter if you end up losing a percent or two a year if you add a little each year. After you have your base foundation, perhaps assembled like we do above, and you’re investing in your other savings plan (Roth, 401k, perhaps taxable investments) and still feel you’d like something that has some liquidity but at higher yields, you may try to assemble a CD ladder or purchase a longer term CD and pay for an early withdrawal penalty if you need it (Ally Bank is one example with favorable early withdrawal penalties, but there are caveats and risks as I’ll note below). For example, if you are making 0.75% in a savings account, purchasing a 5-year CD with 1.6% interest rate will be even with the savings account after 4 months if you need to take an early withdrawal. Though there are risks involved with this approach as Ally must give consent as noted in this article, and if interest rates rise sharply across the board, they will likely invoke this clause to prevent you from selling just to get in at a higher rate.
A CD Ladder is basically an assemblage of certificates of deposits (CDs) with varying maturity dates (and associated interest) set to expire in set intervals, so one is close to maturing and hence more liquid. The Simple Dollar has a layman’s article on CD Laddering for those interested. Unless you are very risk averse, have a lot of cash lying around and are maxing out retirement accounts (and if that’s the case, you probably already know all of these things), it may not really apply.
For those just starting to build an emergency fund, keep chipping away. Dave Ramsey’s Total Money Makeover basically recommends building a $1,000 E-fund and then start eliminating debt. Depending on your situation, I think you’re ok with that approach, but only going so far to remove high interest credit card debt before building up your emergency fund to a 3 month level to start. It may take awhile, so use those on-line savings vehicles to automatically pull money into the E-fund every paycheck so you don’t mix it with your more liquid checking/savings. Small increments over time tend to add up, and provide a nice peace of mind knowing if shit happens, you’ve got it under control, at least for awhile.