Why save? Do you have a specific goal? Is it for a car, a house, or even a dream vacation? Experts say that one of the main and most important reasons to save money is for an emergency fund.
Have you ever had an emergency and had to use a credit card to cover costs? Did you tell yourself it would be a one-time occurrence, and then six months later, your credit card debt ballooned? Credit cards seem so easy to use at the time of an emergency, but there is a huge cost to pay for that convenience. Many credit cards charge an annual interest rate of 19% or more.
To put this more in perspective, let’s say you get into a car accident, and it’s your fault. Your collision insurance deductible is $500, but you don’t have the money to pay the deductible. You think, no problem, I can put it on my credit card. With an interest rate of 19%, if you made the minimum payment of $10, you would end up paying $499 in interest over the eight years to repay this car accident. This is outrageous, yet the average household credit card debt is $15,762. It would take 30 years if you paid the minimum credit balance of $247 to eliminate the average household credit card debt above.
Life at times can throw unexpected challenges at you, so that’s why it is so important to establish an emergency fund. Having cash available when you need it is never a bad thing. The question is how much cash you should hold versus investing the money in something else. Personally, I like to hold six months of expenses in cash in case of an emergency. I look at this cash as insurance against unexpected events. Hopefully, I won’t ever have to spend the money, but knowing it’s there makes me sleep better at night.
Some people will disagree with saving so much emergency cash in a savings account, especially with most banks paying less than 1% interest rates. One of the things that I would encourage that you do is not put your money into a bank checking account which often times does not have a yield or even a nominal yield of 0.05%. Instead, I would suggest setting up an online savings account, which often times yield around 1%.
Which Savings Account?
When I originally set up my emergency savings account, I deposited my money into ING Direct. Soon after, ING Direct was bought out by Capital One 360. When the change first occurred, I contemplated changing banks due to Capital One’s customer service challenges but decided I would give them an opportunity. But, when Capital One 360 changed the interest rate from 1% to 0.75%, I decided that I could do better. I know 0.25% doesn’t sound like very much but $25 for every $10,000 adds up, and more importantly, it was free money for doing 10 minutes of research.
I began my research on Nerd Wallet and quickly decided to switch to Ally Bank, which has been rated as the best online bank for the last five years and also offered one of the highest interest rates in the online banking community. One side note to remember– if you create a savings account with Ally Bank, you will be limited to six transactions a month. So make sure you do not exceed those transactions; otherwise, you will be required to pay $10 for every transaction thereafter.
Finally, you might wonder why I don’t put this emergency savings into the stock market instead of a bank account. While the lost opportunity of investing is somewhat difficult for me to swallow, especially with historically low banking interest rates, in my opinion, an emergency fund is not an investment but an insurance for unforeseen circumstances.
What are your thoughts? Do you have 6 months of expenses saved up? What savings account do you use?