SAVINGS
You need an emergency fund
Keep saving until you have enough to meet 6 months’ expenses
Having a cash stash by any name — emergency fund, contingency fund, rainy-day fund — may be back in vogue after decades of declining savings.
The continuing challenge: How to manage this set-aside money effectively.
Americans saved more than 10 percent of their income as recently as 1985, as measured by the personal savings rate of the federal Bureau of Economic Analysis. After sliding all the way down to 0.1 percent in January of 2008, that rate climbed to 2.8 percent by November.
The modest uptick in savings came in the wake of government rebate checks, but the ongoing financial crisis may block any significant increase for a while. But the deep recession appears to have revived interest in a concept many long ignored while stock prices and home values rose steadily.
Kelly Whalen wasn’t anticipating imminent trouble when she and her husband started an emergency fund last spring
With the economy having since fallen into deep crisis, though, she feels even better about their small head start toward having money to fall back on in the event of job loss or other personal calamity.
Now if only they can keep from having to dip into it for more mundane setbacks like car repairs and higher-than-expected doctor bills. Their fund started with $500 and is currently at $700 after a few withdrawals that threatened to empty it out.
“We keep building up the emergency fund only to have more emergencies!” said Whalen, 32, of Exton, Pa.
Experts’ advice that people set aside three to six months’ living expenses, or a year’s worth if possible, has taken on new urgency in the face of mushrooming job cuts that have pushed the unemployment rate above 7 percent for the first time since 1993.
Whalen, a stay-at-home mom with four children, hopes to get to that point in the not-too-distant future even if her husband Bob’s job in information technology seems secure. For now, though, she is determined to get it up to $2,000 as a “starter” emergency fund.
“It’s not unrealistic to target three to six months,” she said. “But I think you have to do it in small chunks.”
Here are some important considerations to think about:
• Setting up a fund. You want to put the money in a place that offers a decent interest rate and where you’ll be able to access the money quickly. The most common vehicles are traditional bank savings accounts, online savings accounts, money-market funds and CDs.
Manisha Thakor, a Houston-based chartered financial analyst, notes that typically there is an inverse correlation between the amount of interest you can earn and the ease with which you can access your money. “In general, CDs will pay the highest interest rates,” she said. “However, CDs give you the least ‘ready access’ to your funds.”
• When to use it. Defining “emergency” will vary from household to household, depending on individual goals and available money.
“Some [emergencies] are obvious — your car breaks down, you need a last-minute ticket to see a sick relative,” said Thakor. “Others are less so — you need to quit your job to get away from a truly toxic boss or leave a relationship that is dragging you into an emotional abyss.”
• Where to find the best yields. Bankrate.com provides a nationwide listing of the 100 highest-yielding CDs as well as for other investments, based on weekly surveys of over 4,800 large banks and thrifts and smaller banks that pay to be listed. The site allows you to search for rates at banks and thrifts in your area.
• Home equity line a fallback. Building a six-month emergency fund may be a nearly impossible for many. Taking out a home equity line of credit of $30,000 or more can help fill the gap.
Dipping temporarily into the home equity line would enable you to leave other investments with better yields intact. Getting one may be more easily said than done without a stellar credit score, however.
• What to tap first. Say you have a savings account, a money market, a CD and a home equity line; what should you tap first if personal disaster strikes?
Mike O’Neill, a Kansas City-based financial planner with CBIZ who’s also a national board member of the Society of Financial Service Professionals, advises starting with the home equity line rather than liquidating CDs prematurely.
Avoid wiping out money markets and savings accounts completely; something should be held in reserve for the next crisis. Most important of all, he said, is to keep putting money into an emergency fund.
“Most people put the money in and within six months they’ve tapped it,” he said. “So if you’re not putting away 5 percent of your family income toward short-term savings, then you’re going to be in trouble.”
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