Emergency funds: How much you should save—and where to keep it

Whether it's a car that needs major repairs or an aging roof that's leaking water, not-so-welcome surprises have a way of popping up in life. An emergency fund is your financial safety net, giving you a source of cash you easily can tap whenever you hit an unexpected expense, rather than taking on debt.

If you're already setting aside a significant amount of cash for those what-ifs, you're off to a good start. But you also can optimize those savings when you purposefully decide where to keep your emergency fund. You'll want to ensure the money is easily accessible, heartily protected and maybe even gaining value.

A solid emergency fund typically will cover three to six months' worth of expenses. But the truth is, there's no one-size-fits-all target. For example, if you're single and your essential expenses take up less than half your take-home pay, setting aside closer to three months of living costs probably will put you in good shape.

If, however, you're the primary breadwinner in a household with kids, or you are a business owner with variable income, a contingency fund that can handle six months of expenses—or even a bit more—might be a more appropriate goal.

As you consider where to keep your money, look for certain trademarks that can keep your emergency reserves in a healthy position:

Liquidity is the ability to quickly turn your assets into cash. If, for instance, you suddenly learn your job has been eliminated, how are you going to pay for groceries or the electric bill? You need a financial source you can access at a moment's notice.

Principal protection means preserving the value of your initial savings, regardless of the economic situation. To ensure all your money is there when you need it, it's best to avoid investments that carry a significant amount of risk, especially over the short term.

To get the most out of your money, you can seek out an account that grows it over time. Generally, the more liquidity and safety you enjoy, the lower your return is going to be. But you still can look for accounts that pay compound interest, which can ensure your assets keep pace with inflation.

Where can you put your money so you can count on liquidity and principal protection while still generating some positive growth? Consider these four savings vehicles, which provide a nice combo of all these features.

A savings account at your neighborhood bank is probably fine if you're looking to stow away a relatively small amount of cash. But when you're dealing with larger sums, a high-yield savings account at an online bank may be a better choice. That's because most digital banks offer an annual percentage yield, or APY, that's several times larger than that of brick-and-mortar institutions. However, that interest rate can fluctuate based on market conditions.

While some limitations may apply, many allow you to make penalty-free withdrawals, providing the liquidity you need for your emergency fund. The FDIC guarantees up to $250,000 of deposits per customer at each member bank, so you know your principal is safe, too.

A money market account is also an interest-bearing account offered by a bank or credit union. They offer interest rates similar to online bank accounts, but there are some important differences. They typically allow limited check-writing ability, giving you a way to use your deposit if needed. However, they generally require higher minimum balances than you'll see with a traditional savings account, and some may limit the frequency of withdrawals.

Some have tiered interest rates, which means you'll generate higher returns if you keep more money in the account. These interest rates can fluctuate, though, based on the market. Overall, they provide another nice sweet spot with liquidity, safety and growth.

Certificates of deposit, or CDs, typically offer interest rates that are slightly higher than high-yield savings accounts. Plus, most are offered by FDIC members, which means your deposit is secure, regardless of the financial condition of the bank itself. But there is one drawback: Your money is tied up for the duration of the CD. If you access your money before then, you may incur fees or lose interest.

One way around that is to set up a CD ladder, where you hold some money in short-term CDs that you can access in just a few months, and some in slightly longer-term certificates that offer a higher return.

Series I savings bonds from the U.S. Treasury historically have been an extremely safe investment. That doesn't mean you have to settle for humdrum returns, however. A portion of the interest paid on I bonds is linked to the consumer price index, which means it's a nice hedge against inflation.

But there are some caveats. You're limited to buying $10,000 of electronic I bonds or $5,000 of paper I bonds—something you only can buy with your tax refund—per calendar year. And you don't have the same access to your money that you'd enjoy with a bank account. Your money is completely tied up for 12 months. If you redeem a bond in less than five years, you forfeit the last three months of interest. For those reasons, I bonds may be a good way to invest part of your emergency fund, but probably not the entire amount.

Because a financial crunch can happen any time, it may be tempting to stay overly cautious when it comes to storing an emergency fund. But keeping a large amount of cash in your home—or even in a checking account that pays little or no interest—won't allow your funds to grow over time. In fact, your money will generally lose value when you factor in inflation.

In addition, an emergency fund should be separate from your retirement money. You also want to keep it apart from savings dedicated to planned expenses, like the down payment on a home or a new car. Otherwise, you'll be setting yourself back from those other goals whenever you face an unexpected bill and have to dip into your reserve.

Finally, aim to avoid risk when you're dealing with emergency funds. Chasing potentially big returns can put your principal at risk. Stocks and corporate bonds may be a good choice if you have a longer time horizon, but not when it comes to money you may need to spend on short notice. Typically, you also want to steer clear of putting your money in real estate or any other investments where liquidity can be an issue.

A contingency fund is money that's there for you when you need it most. But even with the best planning, there could still be instances when an emergency fund doesn't cover an unexpected financial setback.

A financial advisor can talk through these scenarios and more, helping you identify an amount that makes sense for your situation, suggesting a safe, sensible place to keep it, and putting additional back-up plans in place so you always feel covered.