The 4 best (and worst) places to keep your emergency fund

An emergency fund can provide much-needed relief in the event of financial hardship. However, where you put your rainy-day money can be just as important as how much you save.

If you're unsure where to keep your emergency fund, here are some of the best places to consider. We'll also provide a few options that may be tempting but should be avoided, at least for this particular financial goal.

Key features of an emergency fund account

The best places to keep your emergency savings have a few things in common: Low risk, liquidity, and penalty-free withdrawals. Here's why those features are so crucial.

Low risk

The purpose of an emergency fund isn't to build wealth. Rather, it's to manage potential risks to your financial well-being.

Stashing your money in an account that won't maximize your return might seem inefficient. However, it's more important to avoid potential investment losses that could jeopardize your ability to weather financial storms as they arise.

Liquidity

Liquidity refers to how quickly you can convert funds into cash. Because financial emergencies are rarely predictable, your best bet is to store your rainy day fund in an account that offers quick and easy access to your money when you need it.

Penalty-free withdrawals

Some accounts assess penalties if you withdraw your money before your account agreement allows it. These early withdrawal penalties can wipe out any interest you've earned and even eat away at your principal balance.

Whether you're just starting to establish your emergency savings plan or you've already saved up some cash, here are some accounts that are best suited for holding that money.

1. High-yield savings account (HYSA)

As their name suggests, high-yield savings accounts offer more significant interest rates than traditional savings accounts. In some cases, you can earn as much as 5% APY (or more) on your balance.

High-yield savings accounts are particularly beneficial because they're highly liquid — your money is just a quick transfer away. Plus, there's no possibility of losing any of your principal balance to investment losses. And HYSAs typically don't have minimum deposit requirements.

That said, some of the best high-yield savings accounts come from financial institutions that don't offer checking accounts. If you choose such an account, transferring your money can take a few days.

See our picks for the 10 best high-yield savings accounts available today>>

2. Money market account

Money market accounts function as a hybrid between checking accounts and savings accounts. They often offer interest rates that are comparable to what you'd get with a high-yield savings account, and may also provide a debit card and/or paper checks for easier access to your money.

However, some money market accounts may charge a monthly fee unless you maintain a minimum balance. Additionally, interest rates may be tiered based on your balance, which can limit your earning potential. In general, these accounts are best suited for those with a bigger balance and the ability to meet any requirements to get monthly fees waived.

See our picks for the 10 best money market accounts available today>>

3. Penalty-free or short-term CD

A certificate of deposit (CD) is a type of account that requires you to keep your money on deposit for the entire term. During that time, your interest rate is guaranteed. CD terms can range from a few months to several years.

The drawback is that most CDs charge penalties if you withdraw your money before the account matures. So if you experience a financial emergency, you could lose out on interest and even some of your principal deposit if you need to pull out money early.

The exception is penalty-free CDs, which give you more leeway in accessing your funds fee-free. However, no-penalty CDs typically offer much lower interest rates compared to standard CDs, high-yield savings accounts, and money market accounts.

Alternatively, you could consider a short-term CD of less than a year. While there's still a risk of needing to withdraw money before maturity, penalties tend to be lower on shorter-term CDs.

See our picks for the best CD accounts and rates on the market>>

4. Cash management account

Many brokerage firms offer cash management accounts (CMAs) that you can use to store uninvested funds.

Although they differ from traditional bank accounts, CMAs may offer some of the same features you'd get with a checking or savings account, such as a debit card, mobile deposit, and ATM access. They may also offer high interest rates and more deposit insurance than a traditional bank account.

Keep in mind, though, that some CMAs offer less flexible access to your money than others, and moving money from one to your bank account can take a few days.

Where not to put your emergency fund

The following accounts may be well suited for other financial goals, but they tend to be less effective when it comes to your emergency fund. Here's why.

1. Long-term CD

As with short-term CDs, long-term CDs require you to lock up your money for a set period of time, which can be several years in the future.

While long-term CDs may sometimes offer higher returns, you're more likely to need your money at some point during a period of multiple years rather than a handful of months. What's more, early withdrawal penalties tend to increase with longer terms.

2. Savings bond

Savings bonds are a type of debt security issued by the U.S. government, meaning that they're considered to be extremely low risk. Depending on the type of bond you choose, you may be able to invest anywhere from $25 to $10,000.

However, you can't cash in a savings bond until you've held it for at least a year, and if you do so before the five-year mark, you'll lose three months' worth of interest. It can also take a couple of days to complete the process.

3. Stock market

The stock market may be one of the best places to put your money to build wealth over time, but you can expect stock prices to be incredibly volatile in the short term.

If you experience a financial emergency during a down period, you'll have less money to meet your needs than if you had kept the funds in a safer investment.

Additionally, it can take a few days for the cash to settle after selling off an investment, and then a few days after that to move the money to your bank account. You'll also have to consider potential taxes on any gains.

4. Retirement plan

Depending on the type of retirement account you have, it's possible to withdraw funds without incurring a penalty.

For example, some 401(k) plans offer loans where the interest you pay goes back into your account. Also, Roth individual retirement accounts (IRAs) allow you to withdraw your contributions tax- and penalty-free.

However, you may still be penalized with a 401(k) loan if you don't repay it on time or if you lose your job before completing your repayment. Also, borrowing from your retirement funds might mean that you need to save more money in the future to make up for lost gains.

Bottom line

With so many different financial accounts available, it can be difficult to know where to put your emergency fund to maximize your savings efforts.

While some types of accounts are well suited for other financial goals, it's important to choose one that covers the three bases of low risk, liquidity, and penalty-free withdrawals. Take your time to research and compare several options to ensure you find the best fit for what you need.