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Handling Financial Emergencies
By Virginia B. Morris
Financial emergencies are a fact of life. People get sick,
lose their jobs, and experience financial hardship. The issue
isn't whether, or even when, a problem will crop up that could
strain your bank account. The issue is whether you will be
prepared to handle situations like these with confidence and
without going into debt.
One defensive strategy is to establish an emergency fund,
which is money you set aside in a separate account. The point
of separating this money from the accounts you use every day,
such as your checking account, is that you ensure that the
money will be available when you need it.
You might put your cash reserves in a bank or mutual fund
money market account, or into short-term investments like
certificates of deposit (CDs) or 13-week U.S. Treasury bills.
These are wise choices because they are highly liquid and
can easily be turned into cash. Money market accounts don't
impose a penalty for withdrawing, and even if you had to withdraw
early from a CD, the most you'd lose is the interest and not
the principal. In most cases, you could also liquidate a Treasury
bill without losing much money, if any, by selling through
Treasury Direct.
Another approach is to stagger, or ladder, your CD accounts.
To do so, you divide your total investment amount and buy
CDs with different maturity dates so that one will come due
every 3 or 6 months. In most cases, if you have an emergency
in between the various maturity dates, you should be able
to charge unexpected expenses on your credit card or even
postpone bills until the CD comes due. Similarly, if you stagger
your T-bill investments, you should have money available every
3 months if necessary. And in both cases, if things are going
along without incident or emergency, you can (and should)
simply reinvest.
Yet another strategy, if you want to avoid the downside
of keeping too much money in liquid, low-interest paying accounts,
is to invest most of your emergency fund in a conservative
portfolio of stocks, bonds, and mutual finds. You can always
sell the investments if you absolutely need the cash. Of course,
it's always possible that you could lose some of your principal
if you had to sell on short notice, and the value of your
investments had dropped.
The odds of being in a position where you have to liquidate
at a loss are, statistically speaking, in your favor. And
over the long term, your money has a much greater likelihood
of increasing in value. In addition, you might be able to
use your investment portfolio as collateral to borrow enough
cash to cover your unexpected expenses, either against your
brokerage account or from another lender.
One important question is how much you should actually keep
in your emergency fund. You'll find that different financial
experts suggest keeping different reserve amounts on hand,
although typically they recommend the equivalent of 3 to 6
months salary.
Experts differ significantly, though, on how much a single
woman should keep in reserve. Some advisors believe that a
woman on her own may have more difficulty surviving financially
if she's ill, or may have a harder time making ends meet while
she's looking for a new job. For these reasons, they maintain
that single women should keep more money in liquid emergency
funds than married women or even single men in a similar situation.
The amounts they suggest are sometimes as much as a year's
worth of income.
In order to make the important choices regarding the size
of your emergency fund and how it should be invested, you
must first take a proactive stance and not allow caution to
postpone critical financial decisions.
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