Build Your Cash Reserve
As we have mentioned before at Easy Investing Tips, we believe it is very important to have a cash reserve before you start investing in things like stocks and mutual funds. Additionally, there are times when it is advantageous to horde cash rather than buying traditional investments.
Why Build an Emergency Cash Fund?
There are several reasons to build an emergency cash fund:
- It is your emergency cash fund in case your regular cash flow is interrupted by job loss or a health crisis.
- It is a mental security blanket – less stress when you consider more aggressive investments.
- Other investments can be lost or fall significantly through no fault of your own (see the 2008 stock market).
Stockpile that Cash
This primary emergency cash reserve should be in extremely low risk investments like a savings account or money market account (MMA). We cover those below.
We also think it is useful to create a second emergency expenses reserve. This is for other unexpected situations like major home repairs, auto accidents and repairs, moving expenses, or other health expenses. You can combine this with your major cash reserve, just make sure to earmark the proper amount for the worst case scenario of not having income.
Where to Put Savings - Cash Investments
There are many options for saving your hard earned cash. Our two favorites are the obvious ones – savings, checking or money market accounts (MMA). Other options are certificates of deposit (CD), treasury funds, or even physical gold.
Savings and Checking Accounts
Most people have experience with these types of accounts. They pay the lowest interest rates but are insured by the FDIC up to $100,000 (temporarily at $250,000 currently). We recommend an online account with a reputable bank since you will get a higher interest rate. You can compare the latest rates at BankRate.com.
Money Market Accounts
One clarification – we are referring to the deposit accounts, not money market funds. For most people, MMAs are the same as savings accounts but usually pay a higher interest rate (because the bank has more investment options). They are still FDIC insured like savings accounts, which is important. One difference is that you may only be able to withdraw money a fixed number of times per year before incurring a penalty. However, since this is for an emergency fund, you should not (hopefully!) be withdrawing at all. We recommend going this route for most people since you get slightly more bang for your buck over savings accounts.
Certificates of Deposit (CD)
A Certificate of Deposit is another popular investment vehicle with low risk. It is essentially a time deposit – you commit to leaving your money with the bank for a fixed period, anywhere from 3 months to several years. In exchange, you receive a higher interest rate. Unfortunately, there is a substantial penalty for early withdrawal. Also, your interest does not compound since it is paid separately in most cases.
We do not recommend CDs for your primary emergency cash fund because you want your cash liquid without penalty. However, if you have a large cash reserve with several months immediately available (in a savings/MMA), you can put a portion of the reserve in short term CDs.
US Treasuries and Treasury Funds
Treasury funds invest in US Government Backed Treasuries. These are lowest risk investment you can make since they are backed by the government – the US government has never defaulted. That said, we do not recommend these for most people since the rates are very low (sometimes even negative after fees). The wealthy often turn to these to park cash without risk since they go over the FDIC insured amounts.
Physical Gold
Gold is the ultimate inflation (and deflation) hedge. It can be used during volatile times and when faith in currency is low. It is more of a way to preserve the value of your money rather than an investment. Physical gold should be purchased as bullion (common coins, non-rare) – storage also presents a problem but a home safe or safety deposit box are sufficient for most people. Gold does have a place in an investment portfolio but we do not recommend it for your emergency cash fund.
Summary
We hope that we convinced you to build an emergency cash reserve before moving onto to riskier investments. Our recommendation is open a Money Market Deposit Account with a bank, either online (higher rates) or offline. We like to keep it somewhat simple at EasyInvestingTips.com!