Put your emergency fund where it will do you some good

ByABC News
March 30, 2009, 4:59 PM

— -- Q: Investors are being told to make sure they have an emergency fund. Where's the best place to keep that fund?

A: If there's one place many online brokers are failing, it's in giving investors a place to hide during the bear market.

At a vast majority of online brokerage firms, when you sell stock and hold uninvested cash, you're getting paid abysmal interest rates on that cash. Yes, I realize interest rates are well below year-ago levels. Even so, the rates paid by most online brokers are pretty low.

For example, at one large firm, if you have up to $100,000 in cash in a brokerage account, your money will earn get 0.05% interest. No, that's not a typo. You're getting not much more than zero interest on uninvested cash.

Some brokerage firms offer decent "sweeps," where excess cash is moved into a money market fund. Still, the interest rates are shockingly low. One firm at the end of February was paying 0.282% on its money market sweep.

All this means that as an investor, looking to keep some dry powder in a safe place, you'll likely need to open a different account. The best place would be an online high-yield savings account that has FDIC insurance.

Some of the better known options are INGDirect.com and HSBCdirect.com. As of yesterday, INGdirect was paying 1.50% and HSBCdirect was paying 1.65%. ING has an associated brokerage firm, called Sharebuilder.com.

The difference between a high-yield savings account vs. what your brokerage account is paying can make a big impact on your uninvested cash. Let's say you have $10,000 in your emergency fund. If you leave it in your online brokerage firm's account, it might earn $5 in interest in a year. But at 1.65%, you'd get $165. The $160 difference, I think you'd agree, is significant.

Currently, what you need to do is set up an electronic transfer from your brokerage account to the high-yield savings account. If you need to get the money back into your brokerage account, you can initiate a transfer, which probably will take about three days.