So you’ve worked very hard over the last few months to save three to six months’ worth of expenses in your emergency fund. Foregoing meals out, vacations, and all those little things you used to purchase with whatever extra cash you had, you scrimped to build this fund up with the goal of saving money for the future. Now the question comes down to whether or not you should invest the emergency fund in order to let it grow. Before you jump into this, consider some of the below items.
First, the funds in this account will be used for what it’s named for—emergencies. You need the money as liquid as possible for items such as huge home or car repairs or the loss of a job due to a layoff or a disability. Therefore, investing your emergency fund in your company’s 401(k) or your personal IRA is not the best way to go. Not only can there be fees tacked on to early withdrawals, but you can be hit with even more penalties when filing your annual taxes.
Investing your emergency fund into stocks is also not a good practice. While the potentially quick build-up of extra money is tempting, it can disappear just as fast through commission or filing fees from your stock broker or online service. In addition, taxes will be taken out of your investments at filing time if the stock made a profit in the previous year. The biggest downside to investment in stocks—your emergency fund could be significantly reduced or eliminated altogether if the stocks tank in the market.
If you’re still interested in saving money in some sort of investment, consider a Certificate of Deposit (CD). Insured by the Federal Deposit Insurance Corporation (FDIC), CDs tend to have higher interest rates than standard savings accounts, meaning more money made from your initial principal investment. Plus, there are a variety of maturity time periods you can select; usually between 90 days and five years.
There are pitfalls to investing in CDs. For instance, your financial institution may charge an early withdrawal fee if you decide to close it ahead of schedule. And, like interest gained on other investments, any profits made on CDs are taxed at the end of the year. Consult with your financial advisor for the best course of action.