If you stroll this website or its many discussion boards for long, you'll soon pick up one of the Fools' recurring themes: It's very, very important to set aside a pile of money for an emergency.
While all of us hope for smooth sailing in future years, emergencies happen. The car battery dies, and the brakes fall apart. The dishwasher, refrigerator, and microwave all break on the same ill-fated day. More ominously, you or your spouse could lose your job, get sick, or become disabled.
Having an emergency savings fund to tap into when the going gets rough can save you from relying on credit cards and the spiraling debt problems they can bring. Even if you're sitting on a large pile of stocks, you'll want a cash cushion. You don't want to be forced to sell something at a less-than-optimal moment because the plumber won't accept shares of Google
Most experts, Fools included, recommend you save enough money to cover three to six months of living expenses. Hopefully, this advice is old news to you. If it's not, head over to the Savings Center immediately. Do not pass Go, do not collect $200.
If you have diligently saved that money, then you don't want anything to undermine or erode it, least of all the inevitable passage of time. It's best to park your cash in a place where it's keeping up with, or maybe even outpacing, the ravages of inflation.
So far this year, as measured by the consumer price index, inflation has been increasing at an annual rate of 3.3%. Looking for a yield that meets or exceeds that can help prevent your three to six month emergency fund from dwindling to a less comfortable cushion over time.
Luckily, there are a number of ways to do this.
Savings and money market deposit accounts can be the easiest way to save your money and keep it on hand for those emergency moments. If you're just getting started on an emergency fund, they can be a great idea because they often have very low account minimums. Money market accounts can have more restrictions than plain vanilla savings accounts, so make sure to read the fine print.
But to make this savings option a good idea over the longer term, you'll have to shop around a little bit for one that pays a higher interest rate. Your local bank may not be the best place to go. This is one place where a little research is a good idea; the website Bankrate is one place to start looking.
As I type this, for example, EmigrantDirect.com is advertising a savings account paying 5.05%. Citibank Direct offers an e-saving account paying 5% interest. ING Direct offers savings accounts paying 4.4%.
Certificates of Deposit are another place to start looking around. They can make it a little bit more difficult to get your hands on your money, which might be a good thing if you're trying to keep your mitts off your hard-earned savings. They can pay a higher interest rate than some other accounts, depending on the duration of the CD. The downside is that you'll pay a penalty if you have to redeem your CD before its maturity date, so it might not be the best place to keep all of your emergency cash.
A Bankrate search of 1-year CDs shows many yielding more than 5% right now. A few quick examples: E*Trade Bank advertises a 1-year CD yielding 5.3%, and AmTrust Direct offers a 1-year CD yielding 5.6%.
If you're also thinking about bonds as a place to hold some of your emergency cash, you can get some protection against inflation risk with I Bonds. They are inflation-indexed savings bonds issued by the U.S. government, and the amount they pay is adjusted semi-annually to reflect inflation. You can buy them in a wide range of denominations from most financial institutions or through TreasuryDirect. Their current rate is listed as 4.52% through April 2007.
Like all financial decisions, do your homework in searching for the best interest rate you can find. Check the restrictions and the fine print on any financial product you might be considering, and then weigh whether it will give you ready access to your money if, heaven forbid, that emergency happens.
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