Planning for a Rainy Day

It's an unfortunate fact of life that, sooner or later, many of us will find ourselves in a financial bind of some sort.
That's why everyone should have an emergency cash reserve that can be quickly and easily accessed in times of crisis. Having cash on hand means you won't have to panic if you lose your job, fall ill and have to take an extended leave from work, encounter sudden medical expenses or face a cash crunch because of a downturn in your business.

Maintaining a readily accessible emergency fund also means you shouldn't have to sell long-term investments or be tempted to cash in IRA's or other retirement assets. This can jeopardize your retirement plans and result in some expensive and avoidable tax consequences.

How much do you need to put away for a rainy day? Most financial advisers suggest you have sufficient funds to cover your expenses for at least three to six months - especially if you're worried about job security. The more you earn and the more elaborate your lifestyle, the more money you'll need.
Whatever you do, keep this money safe. Your primary goal should be preservation of capital with your emergency fund, not investment gains, however, you will want to earn as much interest as you can while keeping your money protected.

Consider these alternatives as "parking spots" for your emergency fund:

• Money market mutual funds; these provide a safe place for your money and they usually generate higher returns than bank accounts. You can access your savings within days through the redemption of fund units. Many money market funds also offer checking privileges.
• Government savings bonds; these government-backed securities are safe, pay a competitive rate of interest and can be cashed at any bank on any business day.
• Savings Accounts; usually a lower interest rate than money market funds, but generally guaranteed by the FDIC.

Investments that aren't suitable for an emergency cash reserve include those that lock your money in for a specified period, such as guaranteed investment certificates. Some financial institutions allow you to cash your locked-in investments early, but you may face a penalty. Speculative securities, real estate, or other investments which you may not be able to liquidate quickly.

Investments, such as stocks and bonds, or mutual funds that invest in these securities, are fine for your long-term investment strategy, but market swings could erode your emergency fund over the short term. If short-term cash needs force you to sell these investments during a market downturn, you'll have less than you thought. As well, some of these investments can be difficult to sell quickly, even in the best of times.

Remember, it is possible to be asset-rich and cash-poor. But that won't get you far in an emergency. Keep enough short-term investments on hand to see you through the hard times. Think of this "rainy day" fund as you first line of defense in a financial emergency. With any luck, you'll never have to use it!

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