Many money professionals will give you the generalized advice of “3-6 months of living expenses” with respect to maintaining an emergency fund. But most advice stops there.
In working with my clients I feel it is important they implement this concept. But they also need to be proper stewards of that money while it is waiting to be used, so that inflation doesn’t get the best of them.
That’s why I’m a firm believer in a tiered emergency fund approach.
Tier 1: Cash
When’s the last time you had more than $100 in your wallet, or that you could easily access without having to drop by an ATM or bank?
“Cash is King” is truer in today’s world than ever, in my opinion. And, the more rural of a lifestyle you have, the more important it becomes. (Rural banks tend to be closed in the evenings and on weekends, and limit ATM withdrawals to $200 daily.)
Plus, when you have a central HVAC break on a cold Friday evening in February, cash on delivery motivates a lot of technicians to interrupt their weekend plans, and often gets you a discount on services performed.
In short, cash will turn an all-out family emergency into a minor inconvenience. Keep 20-33% of your emergency fund in easily accessible cash.
Tier 2: FDIC/NCUA-insured savings
Now that rates have slightly risen, there are reasons for having a dedicated bank or credit union savings or money market account again – safety and yield.
If you are fortunate enough to have access to one of these institutions (or use an online one) that has a decent yield when compared to inflation (average of 2% over the last 3 years), put another third of your savings there for safekeeping.
If not, do some rate shopping and consider switching. Or, leave a combined 50% of your emergency fund here and in cash and continue to Tier 3.
Tier 3: Brokerage Money Markets & Ultrashort Bond Funds
This is where a good financial advisor can be a lot of help. Accounts in these two classes can help your emergency fund keep pace with inflation while keeping your funds liquid, unlike CDs which require a commitment to a certain period of time (you never know when an emergency will strike, hence why CDs are not the best option for emergency savings).
Using a tiered approach to your emergency savings can potentially help out in an unfortunate situation and turn a crisis into an annoyance.