You could be thinking about your savings entirely wrong

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Anything can happen.

That’s the mantra we repeat to ourselves month after month as we dutifully carve out a chunk of our paycheck and plop it, untouched, into an emergency fund. You can lose your job unexpectedly. A pipe bursts in your kitchen. Your car breaks down. You get the idea...

Most people stash that money in a traditional savings account. When stuff starts to hit the fan, it’s comforting to know that you’re just an ATM away from your cash, safely swaddled in a blanket of FDIC insurance.  

But if you really think about it, throwing all of your rainy day funds in a savings account makes just about as much sense as stuffing your cash under your mattress and hoping the house won’t burn down.

The predominant advice is to keep enough to cover at least three to six months’ worth of living expenses in the case of financial emergencies. (And some recommend even more.)  Given the median household income of $51,017 and a 25% income tax rate, that means an average worker would need to save anywhere from to $10,000 to $20,000. 

Sure, the worst can happen and you may need to shell out $10,000 for a new roof. But the average cost of financial emergencies annually is only about $2,000 per household, according to the Consumer Federation of America, and just one in three Americans report needing to tap their emergency savings in a given year.

If you’ve saved the requisite $10,000 to $20,000, that’s a lot of leftover cash sitting around in a bank account earning a puny yield. The national average interest rate for savings accounts is 0.17%.

Don’t get us wrong. When it comes to emergency funds, being able to tap your savings as soon as possible should be priority No. 1. But there’s a case to be made for spreading your savings in a way that not only prepares you for the worst but makes your money last longer, and allows it to remain liquid.

“To me, emergency money is not something that a return should even be thought about, but I do believe that you can have extremely short-term savings [that offer a better yield] and make that a part of your portfolio,” says Kacie Swartz, a certified financial planner at Stone Asset Management, Inc. in Austin, Texas.

In that case, maybe it’s time to rethink the traditional emergency fund.

Here are a few better ways to put your money to work:

Online-only savings accounts. If you insist on keeping your emergency fund close at hand, you can’t do better than an online bank savings account when it comes to yield and fees. Without physical branches and paying the humans needed to run them, online banks are free to pass their savings on to consumers in the form of fewer fees and better savings rates. At least a handful offer rates close to 1%. You’re not beating inflation, but you’re getting interest five times higher than most savings account holders, and you’re saving in fees as well. Online banks are generous with sign-up bonuses (over the holidays, Capital One 360 offered $100 to new customers).

Penalty-free CDs. Swartz is a fan of short-term CDs, which are low risk but can offer yields twice that of traditional bank accounts. Look for CDs that have shorter maturity dates of one to five years and consider divvying up your cash among several, just in case you need to withdraw funds early. That way you won’t get hit with fees for the entire lot. There are penalty-free CD options, which you can find at both online and bricks-and-mortar banks. Just shop around to get the best rates. Online banks like Ally offer good rates with the added bonus of no-minimum deposits. “[Liquidating a CD] is not nearly as time consuming as the anticipation of doing the work,” Swartz sys. Shop around for CDs here.

Short-term bond funds. Short-term bond mutual funds invest primarily in high-quality corporate bonds and are generally a lower-risk investment. The bonds they hold typically have durations of one to 3.5 years. “It’s not that much riskier than holding your cash in one CD and [a bond fund] could be even more diversified,” says Swartz.

T-Bills or TIPS. Since bond funds run the risk of fluctuating as interest rates rise and fall, U.S. Treasury bills or TIPS can be an even safer alternative. Treasury bills are backed by the government and TIPS come with an added bonus of inflation protection. “Both of these can be very secure,” Swartz says. “What’s risky is the idea that they’re not going to be returning as much as the rest of your portfolio. It’s a conservative allocation.” If you want even more diversity, think about opening a money market fund (check out rates here), which is a mutual fund that invests in a variety of Treasury bills. Just keep in mind they’re not FDIC-insured.

A healthy mix. Every investor knows the benefits of diversification and you can apply the same idea to your emergency savings strategy. We’d wouldn’t suggest putting any money that you need sooner than five to 10 years down the road in the stock market. But if you’d like to diversify, try spreading your extra cash across more than just one savings vehicle. “For someone with $10,000 to $20,000, at the most they should break it into two chunks,” says Swartz. “Put one chunk in something purely cash and the other in something short term.”

Pay down revolving debt first. If you’re working so hard to save up for a rainy day that you’re taking out payday loans and racking up credit card debt to fulfill you daily needs, it’s time to take a step back. The average credit card APR in the U.S. is nearly 17% and payday loans get away with murder, charging rates of 300% to 400%, not to mention fees. You will wind up paying more in interest for revolving debt than you’d ever earn stashing money in a savings account. Tackle your debt first, starting with the highest interest debt and working your way down, and you’ll save more over the long run.

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