I think it’s a very good idea to hold onto at least 6 months of cash as an emergency fund. But for the average American, that’s a lot of money just sitting around doing nothing. 

If you invested it in the markets, you could earn ~5% per year. Money stored in a savings/checking account, by contrast, pay close to 0% interest. So, is there a way to keep your emergency fund liquid while not giving up on having those funds earn some money in the interim? 

Let’s find out!

How Much Are We Talking About?

Before we dive into strategies for making your cash work harder for you, we gotta determine whether a 6-month cash buffer is enough money to warrant the effort.

The median American earns around $55,000 per year [source]: 

53% of US households have two adults in the workforce. [source] Those households therefore earn ~$110,000 per year. 

Since around one-half of households have 2 earners [source], we can split the difference between $55,000 per year and $110,000 per year to get a rough average household income for the US of ~$82,000. This is pretty close to the actually observed median household income of $70,784 [source]: 

For the sake of accuracy, we can use the median value. This should be the more conservative way to measure whether it’s worth spending time to ensure a 6-month emergency fund generates returns.

If your household had an income of ~$70,000, you would need an emergency fund of ~$35,000 to cover a 6 month emergency. That’s a highly-consequential amount of money for most households. 

Actual Cash On-Hand for Americans

Holding the cash equivalent of half a year’s income is probably even more valuable than I’m giving it credit for. Here’s how much the average US household has in available cash (courtesy of MoneyGeek): 

So a 6 month emergency fund for the median household ($35,000) is ~7x times what median households actually have! That suggests that such an emergency fund is quite important indeed. 

How Much Could Your Emergency Fund Earn?

An emergency fund of $35,000 could earn ~$1,750 per year over the long-term if it was invested in an index fund that returned 5% per year. Considering that $1,750 is 33% of the total available cash that most American households have available, I think it’s fair to say that it would be a very good idea to spend some time to figure out ways to get that money to work harder for you.

Risk Mitigation Requirements

First, any investment opportunities that that we can consider for emergency fund cash must satisfy a 3 restrictive requirements:

Must Keep Cash Mostly Accessible

The whole point of an emergency fund is that the money is available with no warning. It should also be accessible without incurring onerous fees. 

For instance, an 18 month Certificate of Deposit (CD) is currently paying 5.15% annually [source], but if you withdraw the money early, you could be liable for up to 12 months of interest. That would be ~$1,697 for a $35,000 investment. So a backing out of a CD early is clearly not a great outcome.

Must Not Be Exposed to Significant Market Volatility

You are most likely to need your emergency fund when things get tough in the economy. During tough economic times, stock markets tend to drop. So it doesn’t make sense to invest your money into something that mirrors market conditions.

Cannot Require Loads of Work to Manage

If you wanted to invest your emergency fund in the simplest possible way, you could just search for high-interest bank accounts every couple of weeks and move your money around. You might have to do that a dozen times a year, but it would work. It would also require lots of your time. 

If you happen to live in a median-income household and spent 100 hours per year doing this (less than 10 hours per month), you would only be making $17.50 per hour. 

That would be much less than what your work pays you. And you’d have to spend lots of time working through boring bureaucratic tasks. If the idea of filling out bank account paperwork appeals to you, this might be a good option. But for the rest of us, myself included, the idea is to find nearly-passive ways for your emergency fund to earn money. 

Finding opportunities that meet all three of these requirements is tough, but not impossible. Let’s dive into some of the options in the next section.

A Survey of the Options

Using the requirements above doesn’t leave us with a ton of options, but we don’t need a lot of asset types. After all, we aren’t investing millions of dollars and we aren’t trying to strictly maximize our returns. We just need 1 or 2 options that do better than savings and checking accounts that offer essentially 0% interest.

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Certificates of Deposit

Certificates of deposit or CDs are definitely the oldest product on our list. First created in the 1600s in Europe, they first became available in the early 1800s in the US. CDs offer higher interest rates because you cannot access your invested funds until the CD reaches maturity. Here are some decent CD product rates as of early September [source]:

Technically, you could access the funds earlier, but you would have to pay a substantial fee.

For this reason, CDs just barely pass the test for liquidity that we established above. I would disqualify them except that when you need your emergency fund, you actually can withdraw the money. The fees are significant, but wouldn’t be a deal-breaker if you absolutely needed the money. Here’s what the fees look like at some big US banks [source]:

Certificate of Deposit Pros and Cons

Pros	Cons
Typically offer the highest rate of return among low-risk investment options	Must pay a fine for early withdrawal
FDIC insured	Don’t pay interest until the date of maturity

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Treasury Bills

Treasury bills, or T-bills were first created in 1929 as a response to massive government debts incurred in the first world war. They are issued by the US federal treasury as a way to fund government operations. Basically, it’s the government borrowing from citizens in exchange for interest payments later. When printed out, they look sort of like money: 

Today, they are auctioned off in 4, 8, 13, 17, 26, and 52 week increments. If the market expects that interest rates will rise, longer-term bills will have higher interest rates. That’s because the market assumes that borrowing money in the future will be more expensive. Conversely, if the markets think that interest rates will fall, the opposite will occur and the short-term bills will have higher rates of return.

For our purposes, things like calculating par value or face value, the dynamics of the government auction process, and secondary markets for selling the bills early are less important. After all, our third criteria for investing our emergency fund is that it be simple and easy to manage.

You can purchase t-bills directly from the government or from secondary markets. In either case, the bills are typically sold in denominations of $1,000. 

Treasury Bills Pros and Cons

Pros	Cons
Higher interest rates than normal checking or saving accounts	More complicated to buy and sell than other options on the list
No minimum investment amount	Must be purchased in discrete amounts
No default risk since bills have a US government guarantee	Don’t pay interest until the date of maturity
Interest is exempt from state and local income taxes
Relatively easy to sell before they reach maturity

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Money Market Accounts

Compared to treasury bills and certificates of deposit, money market accounts are fairly new. The first money market account, the Reserve Fund, was only introduced in 1971. The first money market accounts rapidly gained traction and assets in these new accounts grew from a paltry $4B in 1977 to $185B in 1981. [source] Here’s what the trend line looks like for the last 70-odd years [source]:

At their core, Money Market Accounts (MMAs) are similar to checking or saving accounts. Account holders can write checks against the accounts, funds are FDIC insured up to the standard $250,000, and most of the major banks in the US offer them. 

The reason that MMAs can offer substantially higher rates of return is that they can invest your money in certificates of deposit, government securities, and commercial paper. The bank manages where the funds are allocated on your behalf, so you don’t need to manage anything. 

All of this sounds pretty good, but MMAs do come with several key drawbacks like low monthly transaction limits, account balance minimums, and for some accounts, yearly fees.

Money Market Account Pros and Cons

Pros	Cons
Higher interest rates than normal checking or saving accounts	Most MMAs have low monthly transaction limits
Check writing	Some MMAs come with yearly fees
Debit cards	Some accounts require high minimum balances
FDIC insured	Account holders may be fined for dropping below account minimum balances
Easy to open and manage
Interest is typically paid every month

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What to Invest In and How Much

Here’s a short summary that highlights the key differences:

Summary of Low-Risk Emergency Fund Investments

Asset	Avg Returns as of Sep 2023	Ease of Management
Certificates of Deposit	4.35 – 5.5% [source]	★★★☆☆
Treasury Bills	4.12 – 5.37% [source]	★★☆☆☆
Money Market Accounts	4.5 – 5% [source]	★★★★★
Source: OverthinkingMoney.com

Given the simplicity of money market accounts, competitive rates of return, FDIC insurance, 100% liquidity, and an investment principle of ~$35,000, I think the money market accounts are the best deal. They offer extremely simple management and competitive rates of return. Here are some caveats that you may want to consider:

How to Allocate Your Emergency Fund

For your emergency fund to be practical, you need to ensure that it is all easily accessible. Even a money market account takes a couple of days to transfer funds. 

I think you should still keep 1-2 months of expenses in hard cash. But you could invest the remaining funds in a money market account with very low risk. If you follow this allocation, you would retain between 17-34% of your emergency fund in cash and the remaining amount “invested” in a money market account. This roughly follows aggressive portfolio theory that advocates for 70/30 allocations between stocks and less risky assets.

What’s the Overall Upside?

Let’s say that you take my advice and take 70% of your $35,000 emergency fund and invest it in a money market account. How much would you actually earn? Here’s a breakdown that answers the question for various durations and rates of return: 

Profit Earned By Investing Your Emergency Fund

How much profit you can expect to earn from investing 70% of a $35,000 emergency fund over time depending on the interest rate.

	5 yrs	10 yrs	15 yrs	20 yrs	25 yrs	30 yrs
4.0%	$5,308	$11,766	$19,623	$29,183	$40,813	$54,963
4.5%	$6,031	$13,548	$22,914	$34,587	$49,133	$67,260
5.0%	$6,769	$15,408	$26,434	$40,506	$58,466	$81,388
Source: OverthinkingMoney.com

With a middling interest rate of 4.5% and 20 years of compounding, your decision to simply keep your emergency fund parked in a more advantageous account will double your emergency fund. That won’t make you rich, but it’s a very low effort change. 

If you only spend 1 hr per year monitoring and sporadically moving to an account that offers a better rate, you would be paying yourself $1,729 per hour. I would definitely be willing to work at that hourly rate!

What’s Next?

If you’re able to build up and hold onto an emergency cash fund, I think it’s likely that you can make essentially free money by holding it in a money market account. 

So, which money market account would I recommend? The obvious answer is just to go with the money market product that your existing bank offers. It might not offer the absolute highest rate of return, but it’s a lot better than earning next to nothing with a savings/checking account. 

If you don’t already have a bank or really want to get the best rate, you can check out reviews like this one from NerdWallet. If I were picking a new MMA account today, I would probably go with Ally Bank’s money market product. It offers a reasonable 4.4% interest rate, there is no maintenance fee, and no minimum balance. Ally is a smaller bank, their customer service isn’t well-rated, and there’s no branch access, but those seem like manageable downsides.

So there you have it, put 70% of your emergency fund cash into a money market account and let the interest payments roll in.

Happy overthinking!