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Unless working on paying down high interest debt, you should strive to have about three to six months of living expenses saved in an “emergency fund.” The purpose of an emergency fund is to avoid turning to credit cards to pay for speed bumps and potholes in your finances.

Where you keep this emergency fund is supremely important.

Accessibility is the first area of concern. You don’t want the money so easily accessible that you might spend it frivolously. On the other hand, you also don’t want the money locked away so tightly that it’s difficult to access during a financial emergency. The key here is balance!

The second concern is the interest rate. You want to earn the best risk-free interest rate possible. There’s no point in parking your money in a no- or low-interest account when much higher paying alternatives are available. The risk-free parts is important, since your emergency fund money must be there when you need it.

With these two concerns in mind — accessibility and interest yield — let’s look at some good and not-so-good account options.

• Checking Account — Checking accounts are terrible places to keep your emergency fund for two reasons. (1) You couldn’t make your emergency fund any more accessible. You could tap it at the ATM, with your Check/Debit Card, or by writing a check. Worse, all your emergency savings are lumped in with your spending money. There’s no separation! (2) Interest rates on checking accounts are pitiful.
• Bank Savings Account — This is better than a checking account. Your money is separated from your regular spending money. Transfers between your checking and savings account are usually instantaneous, which means your money is still a little bit too easy to access. Unfortunately, most banks pay very poor interest rates on savings account.
• High Yield Online Savings Account — For many people, this is the best balance for ease of access and isolating the money. These accounts have no minimum account balance and pay interest rates close to or sometimes higher than money market accounts. Check out EmigrantDirect and ING Direct online savings accounts. Like regular bank accounts, these accounts are FDIC insured. These online savings account are linked to your checking account. Transfers between the two take about three days.
• Money Market Account — Money market accounts are generally offered by investments firms. Although money market accounts are not insured, no one has ever lost money in a money market account, ever.

  Look no further than the money markets accounts offered by the Vanguard Group. Vanguard has significantly lower administrative fees than its competitors. They pass the savings on to you with higher interest rates.Since interest paid on obligations of the federal government is exempt from state income tax, the Vanguard Treasury Money Market Fund is best for people in states with high income taxes, such as California. Everyone else should look at the Vanguard Prime Money Market Fund. The minimum account balance at Vanguard is $3,000.

  Money market funds may be transferred to your checking account in several days, just like an online high yield savings account. You also can get a checkbook for your money market account.

• CDs — Certificates of deposit let you lock in an interest rate for a specified period of time. There are often penalties if you access your money before the CD matures, so these are not the best for emergency savings.
• 28-day (4-week) U.S. Treasury Bills — This is what money market accounts typically invest in, and are my personal favorite. Why let a middle man take a chunk of your interest when you can buy these directly? Treasury Bill interest is exempt from state and local income tax. Treasury Bills must be purchased in increments of $1,000.

  Here’s how they work: Treasury Bill are sold every Thursday at a discount to face value. For example, you buy on Day 1 for $995. On Day 28, your the Bill matures and you get $1,000 back. The difference between what you paid and what you got back — $5 — is your interest. On Day 28, you can either take the money (for an emergency) or continue the cycle by purchasing another 4-week Bill.

  If you have at least $4,000 to invest, you can set up a Treasury Bill ladder. Instead of purchasing all $4,000 worth of Treasury Bills at once, you spread out your purchases over 4 weeks so that part of your fund is available every week.This works best if you can pay for your emergency with a credit card and then pay off the card when your Treasury Bill matures.

• Stocks — You should never invest your emergency fund money in the stock market. Because of their risks, stocks are long-term investments. In the short term, you could lose 50% of your savings. And you’re more likely to have a financial emergency (such as losing your job) when the stock market is down.