The high-yield savings account is the second account in the Phippen Tax Accounts You Need Now series because it is an ideal location for your emergency fund, a fund for unpredictable emergencies. To refresh your memory about this account, here is why you need one:
“The high-yield savings account is the home of your emergency fund and provides an environment where you can contribute the money and forget about it, knowing it will grow over time until you may need it for an emergency.”
Why an Emergency Fund?
Living from paycheck-to-paycheck, but without incurring any debt, may not sound risky. You can pay all your bills on time and in full. You may have a lingering feeling that you should save for retirement, but you are not otherwise behind on your finances.
Then one unpredictable expense happens. Your car is totaled. Your house floods. You lose your job unexpectedly with little notice. You need surgery or physical therapy for an injury. A family member is hospitalized due to an illness. If you live paycheck-to-paycheck, these scenarios are enough to force you to acquire debt.
An individual living paycheck-to-paycheck does not have the funds to cover the emergency, but it is not the initial debt acquisition alone that sends finances into a tailspin. An individual living paycheck-to-paycheck then struggles to pay down the debt because there is not room in their budget to service it. Debts like credit card debts often have high interest rates that can make it feel impossible to catch up on debt acquired from a one-time emergency.
Emergency funds are the backstop that financially saves you in the situations above. They do this in two ways. First, if you have an emergency fund, you can use it to pay for the emergency. However, not all emergencies cost the same amount. The second way in which an emergency fund provides a safety net is that if you are saving a certain amount in your emergency fund each paycheck or month, that amount can be used to quickly service a debt incurred in a more expensive emergency.
For example, Ginny has been saving $150/month in her emergency fund and has $750. She gets in a car accident and repairs cost $800. She cannot quite pay the full amount to fix her car, but she only puts a small amount of the bill on her credit card and is sure she can pay it off the next month since she usually contributes $150/month to her emergency fund. She will even have a small amount of money left over to start contributing to her emergency fund again.
How Much Money Should be in an Emergency Fund?
There is no one right answer regarding how much money someone should save for emergencies. What is clear is that most folks are unprepared: less than half of Americans can fund a $1,000 emergency. If you do not have an emergency fund at all, you may want to start by setting a goal to get yourself in the more responsible half of society.
More sophisticated calculations regarding how much to save center around either (a) covering your salary for a certain number of months or (b) covering your household living expenses for a certain amount of time. A good rule for those with higher risk tolerances is to aim for a three-month emergency fund, meaning you have a pool of money that could cover your basic expenses like housing, food, health insurance, and basic transportation for three months. Those with a lower risk tolerance typically aim to have a year’s worth of living expenses, or even a full year’s salary, in a savings account.
Take us as an example: Xa and Patrick are both risk-averse individuals. When Patrick left his stable Department of Justice job to become an entrepreneur less than a month ago, he had enough money to cover his half of expenses for all of 2023 saved in a high-yield savings account just in case. He saved this even though Xa is still employed full-time and could cover both of their household expenses by stopping retirement savings in an emergency. In other words, Patrick has a risk-averse, 12-month traditional emergency fund in addition to a secondary backup plan.
When it comes to the size of your emergency fund, choose what is right for you. It should cover at least three months of expenses, and it can be as high as you need to sleep soundly each night.
Where to Open an Emergency Fund
A high-yield savings account, of course! However, a quick search of all your high-yield savings account options may feel overwhelming. If you want a comprehensive deep dive of how to analyze various accounts, read Ramit Sethi’s post on 2022 savings accounts. For a more concise outline, here are the basic factors we look for in a savings account:
Annual Percentage Yield (APY): When you research savings accounts, you will see many of them advertising a certain APY. APY stands for Annual Percentage Yield, and is how much your money will grow in a year. Standard amounts for APY fluctuate according to current interest rates. In short, if it is expensive to borrow money, you will get a higher return for saving money. This means right now, APYs are increasing. When it was inexpensive to get a loan in early 2021, APYs were also low at less than 1%. Today it is more expensive to get a loan, but APYs are around 3%. These rates may change depending on when you read this, but an APY of about 3% is great right now.
No fees: Open a high-yield savings account without maintenance fees. The purpose of putting your money in a high-yield savings account is to foster growth and at least partially account for inflation.
Ease of opening multiple accounts: Even if you are opening a high-yield savings account to start your initial saving towards an emergency fund, you may want to choose a bank where it will be easy to open multiple accounts going forward. This allows you to save towards multiple savings goals in the future.
If you have only a small amount of money to contribute initially, you may also want to make sure you open an account that does not require a minimum deposit.
When to Open and Contribute to a High-Yield Savings Account
If you have not opened one yet, open a high-yield savings account today! Even if you can only contribute $25, get started so your emergency fund can start growing and protecting you.
After you open your account, make contributing to it easy by setting up automatic deposits. You can set up an automatic deposit by choosing a particular frequency for contributions, like a date each month, for which money will be transferred from your checking account to your high-yield savings account. For example, since Xa has a salaried position, she prefers to have money transferred from her checking account to her savings account a day or two after her paycheck arrives. You may want to have the money transfer a couple days after your paycheck arrives in order to account for any weekends or holidays.
Once you set up this automatic transfer, that is it! You will automatically contribute to a high-yield savings account. Let it grow, and sleep a bit more soundly at night. If it reaches a point where you can cover your expenses for a certain number of months or years, you can stop contributing and enjoy your interest-growing safety net!
About the Financial Accounts Series: The Financial Accounts Series is a four-part series discussing financial accounts that can improve the health of your finances. The Phippen Tax & Financial Services team will provide a deep dive on each of the accounts listed in Part 1, Accounts You Need Now, before releasing Part 2, Accounts You Need Next. If you would like to seek additional guidance about your personal finances or the specific organization and composition of your financial accounts, please contact Patrick Phippen or complete a new client form if you have not worked with Patrick in the past.
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