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6

You Really Need an Emergency Fund

It's smart to have some emergency funds available for unpleasant surprises that occasionally rear their ugly heads. Your employer relocates to Siberia and your spouse isn't keen on moving, so you're out of work. Your child is discovered to be a tuba prodigy, and you suddenly need to cough up a lot of money for costly tuba camp -- and a costly tuba. You get the idea.

Three to six months of expenses is a sensible amount -- but depending on your situation, you might want to keep a little more or less. If you know you aren't likely to have much trouble getting a new job or earning more money when necessary, you might not need to keep too much on hand. If you have many dependents or don't always find new work too quickly, then consider keeping a larger stash on hand.

Remember not to park any emergency money in stocks. That's too volatile a place -- because in the short run, anything can happen in the stock market. Keeping that moola in a savings account that earns little interest isn't so hot either, though. Fortunately, you have other options. You could keep the money in a money market fund, which will pay you more than a savings account. You might also park the money in short-term certificates of deposit (CDs) or bonds, perhaps staggered so that a portion of the money is always close to maturity.

Here's another somewhat controversial option, if you don't have any or much credit card debt: You might decide to charge a certain amount of expenses to your credit card, up to a certain amount, in times of temporary trouble. Be very careful with this approach, though. If you keep a significant balance on your credit card and you're charged a steep interest rate, a bad situation can quickly get much worse. (Learn about how to maximize your credit rating and shop for a better card.)

Loans are another possibility. If you have family members or close friends who could easily lend you enough to cover your temporary needs, that could work out well. If you own your own home, you might be able to take out a home equity loan to generate some temporary cash.

If you have a brokerage account chock-full of some stocks, you might be able to borrow what you need from your brokerage, on margin. People usually borrow on margin from brokerages to buy additional stock, but you can borrow for pretty much any purpose. Your portfolio serves as collateral. Just be careful -- if you borrow a lot and your stocks suddenly plunge in value, you'll be hit with a "margin call" and may end up losing some of your stocks. We recommend using margin only sparingly, if at all.

If you have a 401(k) at work, you might be able to borrow against that in an emergency, too.

The main idea behind these unconventional alternatives is that, by counting on one or more of them, you'll not have to keep a sizable chunk of money tied up where it's not earning much for you. You can concentrate on building wealth while having a solid plan for emergencies.

Again, be careful, though, because planning to tap 401(k) money or establishing significant credit card debt can end up making matters worse in the long run, if you're not able to recover fairly quickly. If these options make you nervous, then stick with the more conservative alternatives.

Learn more in our Savings Center, where we also offer you some special deals on interest rates.


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