Where do you keep your emergency fund? If the answer is “what emergency fund?” you’re in good company. Well, bad company.

“Just as travelers in the wilderness die without water, investors perish if they have no liquidity,” writes the Wall Street Journal’s Jason Zweig in The Little Book of Safe Money.

“Liquidity” is a fancy term for cash or stuff that can be easily turned into cash. A savings account is liquid. Home equity is not liquid. If you show up at the bank and ask for the contents of your savings account, they’ll hand over a stack of Benjamins (or Hamiltons, depending on your balance). In good times, home equity can be turned into cash, but it’ll take some time and you’ll pay a price.

“Hint: The typical American family is dangerously illiquid,” Zweig adds.

We have numbers to back him up. Scary numbers. In a paper published in March, three researchers found that nearly half of all Americans would be “probably” or “certainly” unable to come up with $2,000 cash within the next month.

You might assume that they’re only talking about whether people have $2,000 sitting in a savings account. Or that the “certainly unable” folks represent the lowest-income Americans. Wrong on both counts. Respondents were given fourteen options for raising the cash, ranging from hitting the ATM to selling their house. In between we find painful choices like taking a 401(k) loan, using a credit card, borrowing from a family member, or going to a pawnshop or payday lender.

Oh, and as for this being a low-income problem, the researchers found that nearly 25 percent of households with income between $100,000 and $150,000 said they’d have a hard time coming up with $2,000. The paper explains that this “may be less shocking when one considers costs of living in urban areas, costs of housing and childcare, substantial debt service, and other factors[.]”

I know it insults your intelligence to even mention this, but emergencies of this magnitude are common. Perhaps you have a high-deductible health insurance plan (or, for that matter, no health insurance) and you get a funny rash. Maybe your car needs a valve job. (Okay, I don’t have a car, but I hear about valve jobs on Car Talk.)

“Lose your job, get divorced, fall ill, become disabled, or simply suffer the rising costs of family life—and suddenly you may need to turn your assets into cash not decades down the road, but right now,” as Zweig puts it.

Liquidity is something to keep in mind any time you’re making a financial decision. You can buy a house with a sizable down payment and a reasonable mortgage, but if it sucks up all your cash, then the inevitable first emergency will leave you contemplating that sad list of expensive options. A lot of companies found out about the danger of illiquidity in 2008 when it turned out nobody wanted to be paid in mortgage-backed securities. Cash only, please.

Where to stash it

This is a very long way of saying, yes, you do need an emergency fund, and you need to keep it somewhere actually safe, not fairly safe. Any time interest rates are low, however—and right now they’re Barry White low—it’s painful to watch your money sit there earning nothing. Then financial discussion boards light up with people asking, “My emergency fund is earning 0.05%. Can’t I do something? Could I just put a little of it in the stock market? Pretty please?”

The answer is: if you have a substantial taxable investment portfolio, you don’t have to cordon off a section of it and declare it to be the emergency fund. But that doesn’t describe my situation or the situation of most Americans. We need emergency funds. (Incidentally, if you’re Canadian, continue feeling smug: only 28 percent of you would have trouble coming up with $2,000.)

An emergency fund isn’t an investment. It’s insurance against taking on high-interest debt or having to borrow money from a family member, which always ends well. Insurance costs money. I expect and fervently hope to lose money on my life insurance premiums, but I’m happy to pay up.

That said, you don’t have to settle for 0 percent interest on your emergency fund. You can do a little better, but not much. If someone alerts you to an investment that is allegedly safe but pays a much higher return than an FDIC-insured saving account, that’s a risky investment in disguise. Remember Icelandic savings accounts?

Here are the safe options.

Online savings

Available through many banks, these online-only accounts pay about 1 percent (more than most brick-and-mortar banks) and give you access to your money within two to three days (still liquid, but just out of reach enough to prevent you from spending the funds on dumb impulse buys). You can compare online savings rates through Mint.

Reward checking

Available through credit unions and community banks, these accounts can pay upwards of 3 percent, but you have to jump through some hoops. Most commonly, you have to use your debit card at least a dozen times a month or forfeit nearly all the interest for that month. You can use reward checking as your regular checking account and also keep your emergency fund in it to earn the high interest–but that means you have to trust yourself not to blow through the emergency fund while swiping your way through those required debit transactions. If you’re the kind of person who can’t stop before hitting the bottom of the Fritos bag, this probably isn’t going to work for you, either.

Breakable CD

I wrote last year about the Ally Bank 5-year CD, which currently pays 2.37% interest and charges a paltry two months of interest for breaking the CD early. Some credit unions and community banks offer equally breakable CDs, so check with yours. If you do put your emergency cash into CDs, split it up into multiple CDs so you don’t have to pay the penalty on the full amount in the event of a small emergency. (Some banks offer partial withdrawals from CDs; Ally doesn’t. Read the fine print.) Mint also has a tool to let you compare CD rates and terms.

I-bonds

Series I US Savings Bonds are the closest you’ll get to secret sauce in the world of investing. They pay enough interest to keep up with the rate of inflation. If you buy an I Bond today, it’ll pay 4.6 percent for the next six months and then some undetermined rate for the following six months. I Bonds have two big drawbacks, however. The most you can buy in one year is $10,000 per person. And you can’t cash them in for at least one year after purchasing them, period. Do not let the 4.6 percent interest lure you into sinking your whole emergency fund into I Bonds. But adding a small portion each year? Sure.

My emergency fund is 85 percent in Ally 5-year CDs and 15 percent in I-bonds. It’s enough to cover nine months of expenses, and yes, it took many years to save that up.

None of these options are going to revolutionize your life or whiten your teeth compared to just letting your emergency fund sit in a dumb savings account. Maybe you’ll never touch the money and it’ll just sit there taunting you. Maybe your airbag will never go off, either. Here’s hoping.

Matthew Amster-Burton is a personal finance columnist at Mint.com. Find him on Twitter @Mint_Mamster.

Related