There’s much discussion about the importance of having an emergency fund, and even how much it should contain. Less discussed however is where to keep your emergency fund? Complicating the question is the fact that there are so many potential places you can have it that it can get confusing.

Let’s start by looking at what an emergency fund is supposed to do. The purpose of an emergency fund is to have a source of ready cash to draw on in the event of an unexpected and unpredictable event. For this reason, an emergency fund needs to have two characteristics above all others: liquidity and safety of principal.

Based on these two factors, let’s take a look at the best—and worst—places to put your emergency fund cash.

The best places to keep an emergency fund

All three of the vehicles below fit the bill for liquidity and/or safety.

Bank savings account. This is probably the single best place for an emergency fund because the value doesn’t fluctuate due to market forces, the funds are federally insured, it pays interest (a little at least) and you have complete liquidity in the event the money is needed. Also, since it’s most likely held in a local bank, you have direct physical access to the money.

Money market funds. This is probably the next best place for an emergency fund. The value doesn’t fluctuate, you earn interest (but again, not much), you have complete liquidity and—if the funds are held in a bank money market account—the funds are federally insured.

Cash “under the mattress”. With cash on hand you have stable value and the highest form of liquidity—after all, it’s already cash. You don’t however have federal insurance and there is no interest income. In addition, cash has the added risks of theft and physical destruction due to fire. Still, having a portion of your emergency fund stored in cash (for liquidity purposes) may be worth having. Most emergency money should be in a savings or money market accounts.

Places you probably don’t want to keep an emergency fund

People are always flirting with the idea of maximizing return on their emergency funds. Most attempts to do this compromise liquidity, safety or both.

Certificates of Deposit. CDs meet the safety requirement of an emergency fund, but they can reduce liquidity. Since Certificates of Deposits are time deposits, you tie up your money for a specific period of time in exchange for a higher return. You can always liquidate a CD early, but if you do there are early withdrawal penalties you have to pay, and that can wipe out the higher return and a little bit more.

Checking accounts. These offer liquidity and safety just like savings accounts, but they don’t pay interest. Also, checking accounts are accounts where money is stored mainly for the purpose of being spent; that might be just a little bit too liquid for an emergency fund.

Mutual funds. This is a popular way of maximizing return on an emergency fund and it can seem totally brilliant in a rising market. But once you move your money into one it effectively removes the emergency fund capability. Mutual funds are based on stocks, which brings fluctuating values into the mix. And not only are there fees associated with buying and selling mutual funds, but if you sell a fund that’s lost value to take care of an emergency, you’ll lock in your loss for evermore. Mutual funds are investment accounts, and no place for emergency funds.

Cash “under the mattress”. This is on both lists because a little bit of cash on hand might be a good idea, but too much can be a disaster. Cash completely lacks physical safety, and for that reason it might not be available in the event of an emergency—like when the emergency is a fire that burns the cash you were counting on to tide you over.
An emergency fund needs to be a dedicated account with a very specific purpose. When we start adding in other functions—like maximizing return on investment—we effectively remove the emergency protection that the fund is supposed to provide. Look for safety and liquidity, and use other funds to chase higher returns.

Where do you keep your emergency fund?