Everybody knows it's a good idea to keep some cash in reserve. Lately, rising interest rates have created several opportunities for rainy-day funds to do a better job of keeping pace with inflation, even while staying liquid.

But of course, nothing is perfect. So here are a few suggestions and warnings about where and how to keep emergency cash.

Money Market Accounts
Where to park currency reserves depends partly on your time horizon and goals.

“The longer the time period and/or the less precise amount you need at any point in time gives you more flexibility in being able to possibly obtain a higher yield,” said Gene Balas, an investment strategist at Signature Estate & Investment Advisors in Irving, Texas. “For example, maintaining an emergency savings fund for an indefinite period of time is different than parking cash temporarily to meet a specific obligation in the near future.”

The easiest place to deposit a nest egg is the bank. Savings account rates vary widely. In general, you’ll do better with a money market account.

“Money markets have actually become a real asset class, with many online banks offering competitive yields,” said Brett Bernstein, CEO and co-founder of XML Financial Group in Rockville, Md. “That is the first place we talk to clients about.”

Money market accounts from banks and credit unions offer yields that are based on prevailing interest rates. As rates move upward, these accounts pay out more. According to Bankrate, money market account rates are currently around 3%, and some go as high as 3.25%.

The rate you get, however, may depend on how much you put in. There may also be limits on how many withdrawals you can make per month. But overall, money market accounts are liquid and typically FDIC insured up to $250,000.

“The second place we consider are short-term CDs,” said Bernstein, referring to certificates of deposit from a bank. Also FDIC insured, many of them are currently paying out a percentage point higher than money market accounts, as measured by Bankrate. But to get those higher rates you have to tie up your money for a year or longer.

To be sure, these yields still might not sound adequate.

“Banks are quick to lower rates on savings, money markets, and time deposit accounts when interest rates are falling [but] slow to increase deposit rates when interest rates are rising,” said Dustin Gale, a senior wealth advisor at Kayne Anderson Rudnick in Los Angeles.

So, in time, the payout rates may get better.


Money Market Mutual Funds
Gale is among those who prefer money market mutual funds. Unlike money market accounts, money market funds are sold by brokerage firms. They are investment securities that pool money and put it in debt instruments with short maturities and low credit risk. They also “tend to move more in lockstep with the federal funds rate and are currently paying higher yields,” he said.

In mid-November, the Crane 100 index of the largest money-market funds yielded 3.45%. Note, however, that the yields adjust daily.

These funds are somewhat less liquid than bank accounts, however. Many offer check-writing privileges, but if you need all your cash quickly you might be out of luck. Processing large withdrawals often takes 24 hours. Also, money market funds are not FDIC insured, making them “a notch up on the risk scale,” said Gale. “But the potential reward may make it a beneficial move.”

Still, clients should beware of outsize promises. “When you see a money market with a dramatically higher yield than its peers, that can sometimes be a red flag that the fund is taking on some additional risk to help boost its yield,” said David Zabela, a financial advisor at Fort Pitt Capital Group in Pittsburgh.

Other advisors are more enthusiastic about Treasurys. Treasury securities are backed by the U.S. government, so they are safe. There are no commission fees for purchasing new issues. And with rising interest rates, the yield on Treasurys is better than it’s been in many years.

As of mid-November, the yield on three- and six-month U.S. Treasurys was more than 4%, and a one-year Treasury was yielding closer to 5%. 

“We have been recommending direct investments in Treasury bills,” said Brian Frank, co-owner and portfolio manager at Frank Capital Partners in Key Biscayne, Fla., referring to the fact that clients can buy T-bills directly from the government at TreasuryDirect.gov; they don’t have to go through a brokerage firm.

But with the Federal Reserve on course to continue hiking interest rates, the yield on Treasurys is likely to keep going up. So advisors like Frank recommended sticking with short-term T-bills for now.

“You can keep short-duration [Treasurys] while constantly rolling them over into higher paying [Treasurys] as yields rise,” said Frank. “The risk is if rates fall, you will be investing into lower yielding securities.”

Treasury Ladders
No one expects rates to fall anytime soon. But just in case, some advisors recommended buying a few longer-term Treasurys as well, just to lock in the current high rates. Some suggested buying a variety of Treasury durations, to create a Treasury bond “ladder.”

“Ladders may make sense, but that depends on your time horizon,” said John McCafferty, director of financial planning at Edelman Financial Engines in Alexandria, Va. Long-duration bonds tie up funds longer, of course, so there “may be a lack of liquidity when you need it most,” he cautioned. “If your horizon is three years or less, I recommend avoiding ladders.”

For the moment, with the yield on one-year Treasurys higher than the yield on longer duration Treasurys such as the benchmark 10-year—an anomaly known as “an inverted yield curve”—some advisors are against laddering altogether.


Jeff Fishman at JSF Financial in Los Angeles said he “does not recommend laddering now, preferring to stay with short-term Treasurys.”

I Bonds
Yet another type of government bond has many advisors even more excited. Inflation-indexed savings bonds, or “I Bonds,” are currently offering 6.89% annual yield for those who buy before April 30. (They, too, are available through TreasuryDirect.gov.) The annualized rate, partly based on inflation, is reset every six months.

“I Bonds are government-backed [and] state- and local-income tax free,” said Stuart Katz, chief investment officer at Robertson Stephens Wealth Management in New York City. Federal income taxes, however, are payable every year or can be deferred until redemption. They can also be eliminated if the proceeds are used for higher education expenses at eligible institutions.

But “there are liquidity and maximum-investment-size considerations,” said Katz.

Among the restrictions, I Bonds cannot be traded on secondary markets; you can only buy them and redeem them directly from the U.S. Treasury. In addition, you must hold each I bond for at least a year, and if you redeem it within five years of purchase you forfeit the preceding three months of interest.

What’s more, the maximum purchase price is $10,000 per account per year for electronic purchases (or $5,000 if you buy them in paper form).

“A couple may invest $20,000 and purchase another $10,000 for each child,” said Katz. “Another $5,000 of I bonds may be purchased with your tax refund, for a total of $15,000 a person.”

This dollar limit is “a deterrent for some investors, but the yield can’t be beat,” said Michael Kazakewich, a partner at Coastal Bridge Advisors in Westport, Conn., adding, “I Bonds can be great vehicles for investing gifts made to minors.”

Also, as zero-coupon bonds, they pay no interest directly to bond holders until redeemed. Instead, interest is added back to the value of the bond, compounded annually. They will continue to earn interest for as long as you hold them, up to 30 years. They never lose value.

Still, since you have to wait so long to claim your accrued interest, “they might not be a good way to supplement one’s income or cash flow needs,” said Wendy Norman, an investment specialist at Signature Estate & Investment Advisors in Los Angeles.

In other words, to get the highest returns you have to give up a degree of liquidity.