Emergency Funds

Clearly, life's little disasters are not a whole lot of fun. But even worse is not being prepared for them.

This is why you're always hearing that you should sock away three months' living expenses for a rainy day. There are several kinds of rainy days: the car repair, dental work that isn't covered by insurance, or the downsizing that leaves you looking for work. It's a lot easier to focus on the matter at hand -- getting a wisdom tooth yanked or interviewing for a great new job -- if you're not worried about how you're going to pay your bills.

If you know you'll be staying in your job for a while, you might choose to invest in your company's 401(k) instead of maintaining a huge emergency cushion. Just remember that little emergencies DO crop up regularly, so it's a good idea to have a cushion of some size at all times.

Where to Stash the Cash

Don't, however, take a big wad of money and let it collect dust in a savings account, or in a box under your bed, which is basically the same thing. Also avoid being tempted by a certificate of deposit (CD) account, which earns you a higher return in exchange for locking up for money for a longer period of time. It's not a good idea to lock up your emergency fund, because you won't be able to get to it when you need it.

  1. Aim to save three months' worth of expenses for emergencies
  2. Put the money in a liquid, interest-bearing account such as a money-market account
  3. Remember that borrowing against your 401(k) can be an alternative emergency fund
  4. Keep your emergency fund funded

Find a bank that will offer you a money market mutual fund or a straight money market account, which typically has a higher interest rate than a savings account. Invest your emergency money in something that will earn you a decent return -- aim for 5 or 6 percent -- but don't get carried away. Your emergency fund is not the best place to look for big gains -- that is, no risky stocks.

Raiding Your 401(k)

Another source of emergency funds may be your retirement fund at work. If you have a 401(k), you can often borrow from it and repay the money later on. Check with the benefits manager at your company to find out whether you're eligible. If you are, you may not need to keep as large an emergency stash handy.

And a final thing to remember: When you dip into your emergency fund for, well, an emergency, don't forget to replenish the fund when you earn a few extra dollars. The only way to have an emergency fund available is to keep it funded. So the next time disaster strikes, you'll have at least one less thing to worry about.

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