Ask the expert: Are money market accounts the best fit for emergency funds?

February 10, 2011

| MoneyRates.com Senior Financial Analyst, CFA

Q: I've been using a money market account for my emergency fund, but I'm getting sick of the low interest rate. Now that the rate has dropped below 0.50 percent, I'm thinking of making a change. I have an investment portfolio which always has some cash in it from dividends or stock turnover--why shouldn't I put all my money in that portfolio, and just consider its cash to be my emergency fund? In the meantime, at least the money would be more productively invested.

A: With money market rates now down to an average of 0.22 percent, according to the FDIC, some impatience with returns on emergency funds in a money market account is understandable. However, investing emergency money in an active stock and bond portfolio could have two outcomes which would be less than ideal:

  1. Cash in an investment account is usually there for liquidity purposes--that is, it lets you or your investment manager pull the trigger on buying a stock without having to sell another security. This cash position is usually kept at a minimum so that it doesn't dilute the returns of the portfolio, but if you start withdrawing from it unpredictably (which, after all, is the purpose of an emergency fund), you may interfere with the portfolio's trading, resulting in bounced trades and/or missed opportunities.
  2. You could simply keep a higher cash position in your investment portfolio as a cushion against withdrawals, but this wouldn't accomplish anything. That cash position is essentially invested at money market or similar rates, so you wouldn't be any better off than where you started.

You may do best by sticking with the money market account, but shopping for a better rate. Or, if you rarely ever dip into your emergency fund, you could look for a longer-term CD with a low early-withdrawal penalty, and raise your yield that way.

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