Emergency funds must be risk-free and quickly accessible. That means you should keep it in a typical savings account.
A new study in the Journal of Financial Planning suggests a different strategy. It says that leaving three to six months of living expenses in cash savings may be a bad idea for some people, given the recent surge in financial markets. That may be good advice for financial planners, but it's not for the average person.
The basic principle outlined in the study is that the cash could be earning more money if you put your emergency stash into diversified investments and thereby make your fund grow more quickly. The study's authors do admit that a risk to this approach is that you may need to pull money out of the market when it is down. I’ll say!
This approach may work for consumers who already have substantial net worth and are already investing in the market. But for everyone else, my take is that investing in an emergency fund is a bad idea. There is a saying that comes to mind: "With great risk comes ... great risk." Emergency funds allow you to sleep at night and safeguard your family when bad things happen. It would take more than a few percentage points of return to get me to risk that secure feeling.
If you're interested in investing your money, Bankrate's simple savings calculator can show you how much your savings will be worth over time.
But my advice to you and anyone else who's considering investing their emergency savings is to step back and remember what the money is for. By its very nature, an emergency fund would be needed with little or no warning.
I agree that investing your money is an essential part of financial planning. But as the Debt Adviser, my main concern is to keep you out of financial trouble. Socking away six months to a year of living expenses is a great way to be prepared for whatever life throws at you. For my readers who don’t have emergency savings, start now!