You Really Need an Emergency Fund

It's smart to have some emergency funds available for unpleasant surprises that occasionally rear their ugly heads. Maybe your employer relocates to Siberia, and your spouse isn't keen on moving, so you're out of work. Or 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 to keep on hand -- 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 around. If you have several dependents or don't always find new work too quickly, then perhaps consider keeping a larger stash.

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 would. You might also put 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. One company, (Nasdaq: RATE  ) , specializes in providing savers with a list of banks that offer the best rates.

Here's another option -- likely a controversial one -- if you don't have any or much credit card debt. You might decide to charge expenses on your credit card, up to a certain amount, if you run into 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. Our Home Center provides you with lots of information about these loans, as well as other things having to do with houses and mortgages.

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 sparingly, if you need to use it at all. (For the scoop on how to find the best brokerage for your needs, check out our Broker Center.)

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 even more in our Savings Center.

Bankrate is a Rule Breakers recommendation.

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  • Report this Comment On July 26, 2015, at 3:44 PM, coffeedoc1 wrote:

    I designate the excess cash value in my blended whole life insurance policies to be my emergency fund. I can have the money sent to me in 5 business days (any more urgent need can be floated on a credit card until the Insurance check arrives and then paid off before interest accrues). If the emergency is of a short term nature, I can take the insurance money as a loan to be paid back after the emergency has passed (with a differential interest rate of only 0.7% between what the insurance company charges me and what they pay me on the cash value in my policy). If the emergency is permanent, I can take the money out of the policy as a withdrawal, which lowers the total death benefit but does not have to be paid back. Meanwhile, the cash value in my policy can never go down with the market and earns 3.5% per year, year in and year out while I am not having emergencies - beats any bank savings account or CD and even beats the safety and returns of most bond funds or even the dividend funds mentioned above (which yield less than 3.5% and can go down with market fluctuations.) Safe, secure, liquid and has the added advantage of providing death benefit to my family. In my opinion it is the perfect place to hold emergency fund money. coffeedoc1

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