Dear Dr. Don, I have a $10,000 emergency fund sitting in a savings account insured by the Federal Deposit Insurance Corp., or FDIC, at 1% annual percentage yield, or APY.
What would be the best way to safely invest this money? I am skeptical about money markets, and certificates of deposit have comparable APYs -- if not lower. I'm already contributing to a Roth individual retirement account. I'm not sure where to go from here. -- Brent Buildup
Dear Brent, When it comes to deciding where to invest your emergency fund, the key is liquidity. You sacrifice yield for the immediate access to your funds without the market risk of losing principal when you cash out of the investment.
That said, it pains most consumers to have their emergency funds sitting in an account earning next to nothing in yield. If things go well, you're never going to have to touch those funds, and you want that money to grow over time.
One compromise is to invest in FDIC-insured five-year CDs, and accept the fact that you'll get hit with an early withdrawal penalty if you have to cash in the CD. As of mid-September, you could earn an APY of 2.34% on a five-year CD -- more than double what you're currently earning. Just make sure you understand the early withdrawal penalty before you commit. With a little comparison shopping, you may find a CD with a good yield and a low penalty provision.
The stock and bond markets just aren't the place for investing your emergency fund. Save those markets for your Roth IRA account.