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You can build an emergency fund anywhere—a basic savings account, a piggybank, or even a stash of cash hidden under your mattress. But if you really want to help your savings grow, you need to be picky about where you stash them. A high-yield account and a money market fund promise different advantages as your emergency fund vessel. Let’s find out more about them below.
Why Do You Need an Emergency Fund at All?
But first, let’s discuss the elephant in the room. What does it matter whether you have a money market fund or a high-yield account? What’s the point of savings at all?
It can be difficult to rationalize saving some of your paycheque for a hypothetical rainy day when you could use that money every month on other, very real expenses. After all, you have an online line of credit and a couple of credit cards in your wallet. Instead of savings, you can rely on these accounts to help you when you must make an expensive repair or purchase.
These credit accounts are no doubt convenient, but this thinking is flawed. All loans cost money, and the interest and finance charges on credit compound if you can’t pay off your balance in one go. That means you owe even more than you use, and the longer it takes you to repay your debts, the more debt you owe.
Compare this to your savings, which are free to use and require no payment plan. Using your savings couldn’t be easier. That’s why the line of credit has earned its nickname as a financial safety net. A line of credit is designed to be a backup safety net to the true star of your finances, your emergency fund.
When you understand your line of credit in this way, you can use it as an eleventh-hour backup to your savings like it was intended.
Having zero savings is a reality of your emergency fund, even if you save diligently every month. You might have to drain your savings to cover a roof repair or replace your car’s front brakes. If another unexpected expense arrives on the heels of these expensive repairs, you might not have enough savings to handle everything. You can rely on credit in these tough situations.
A line of credit affords peace of mind until you can pay your emergency fund back.
What Are Money Market Funds?
Money market funds are low-risk mutual funds that invest in short-term securities like government bonds and high-quality corporate debt. These funds offer a convenient option for accessing low-risk investments managed by financial institutions.
Depending on the fund, you can earn as much as a 10% return on your savings this way, allowing your money to grow faster through compound interest. Compare this to the average savings account, which can only provide 0.55%. You stand to earn 19 times more in interest by leaving your money in a money market fund.
Before you transfer your money, you need to know that the money market fund’s impressive return might be behind a paywall. Some financial institutions insist you deposit a higher initial investment or maintain a certain balance to qualify.
Because they are an investment, money market funds are also not FDIC or CDIC insured. That means you could lose your entire investment if something catastrophic happens to your financial institution. While unlikely, the recent collapse of the Silicon Valley Bank proves it isn’t impossible.
Another thing that makes these funds unique? They might come with cheques or debit cards, making it easier to tap these funds to make an emergency purchase in real time.
What Are High-Yield Savings Accounts?
High-yield savings accounts are true savings accounts, unlike the investments discussed above. But unlike the basic savings account, a high-yield account promises a higher interest rate. Today, some of the biggest banks and online financial institutions offer 4–5% return on deposits.
Remember from earlier how little the average basic savings account offers in terms of interest. A high-yield alternative promises nearly 10 times that.
While 5% may only be half of the average market fund’s rate of return, the high-yield account does offer other advantages. As a true savings account, it comes with FDIC insurance to protect your money, no matter what happens to the financial institution.
These high-yield accounts also usually don’t come with restrictions like initial deposits, balance minimums, or withdrawal delays. Instead, you can start a high-yield account with as little as $10.
Of course, the more you save, the more you can earn in interest, so it’s best if you open an account with as much as you can handle. However, these restriction-less accounts make it easier for the average person who may not have $5,000 to open an account.
Money market funds and high-yield savings accounts offer ways to grow your money with varying levels of risk and return. Your choice depends on your financial goals, risk tolerance, and liquidity needs for your funds.
So, which one will you choose?