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Plan Well, Retire Well

Saving and investing your money

Meet the New Superhero: Your Emergency Fund!

I just took my car in for an oil change. I didn't expect an oil change to run more than $500. But when the mechanic gave my car a once-over, he found two things that really needed to be fixed. I'm glad he found them before these things caused bigger problems. But $500 in car repairs wasn't exactly in this month's budget. So it's Emergency Fund Superhero to the rescue!

I regularly talk about the need to have enough money to cover 3 to 6 months' worth of expenses where you can get your hands on it easily (in financial terms, it's liquid). But recent events have pointed out just how important those funds can be. A good friend of mine just received a layoff notice. He's married, and his wife stopped working over a year ago when they had their first child. I was so glad to find out that he actually has an emergency fund! It may not be as big as the recommended amount, but just knowing he has money to pay the bills for a few months really takes some of the stress off.

It's tornado season here in Illinois, and we all run the risk of having flooded basements, wind and hail damage, or worse. Many of those things might be covered by insurance, but would you have the money on hand to pay to have a fallen tree removed from your driveway.

Maybe you don't have an Emergency Fund Superhero yet. How do you get started building one?

If you have a checking account, you can start by building up the minimum balance that you always have in your account. When my husband and I were first married, we "hid" a few hundred dollars there. The balance we showed in our checkbook register was a few hundred dollars less than what was really in the account. Not seeing the bigger balance reduced the temptation to spend it.

When we had accumulated a bit more, we moved that emergency money to a seperate account. Over the years, it's been in different places depending on where we could get a good interest rate. Once you've got several hundred or several thousand dollars, you care about whether it's earning 1% or 4% interest! At one point, we set up a savings account with an internet bank that was offering the best interest rates at the time. We transferred money directly from our checking account to open it. We could easily transfer additional money into the savings account to add to our emergency fund, or transfer it back to our checking account if we had an emergency and needed to use it. It was all done online, without even the cost of a postage stamp.

We've also used a money market fund. These are offered by mutual fund companies. Money market funds usually pay higher interest rates than bank savings accounts. They are not insured but they are considered to be very safe. You can check interest rates and minimum opening balances at Also look at the expense ratio, which tells you how much it costs to have money in that fund.

At another time when savings bonds were offering market interest rates, we bought bonds with most of our emergency fund. Today, savings bonds aren't a very good option. They are paying a fixed interest rates of just 1.4% (for bonds sold through October 2008) . You can't cash a new savings bond until you've owned it for one year, so you don't use your entire emergency fund to buy savings bonds all at the same time. And you'll give up 3 months of interest if you hold the bond less than 5 years. I-Bonds (inflation protected bonds) are paying a much better interest rate right now (4.84%). But the other savings bond restrictions still apply: you must hold them for 1 year and you'll pay an early redemption penalty if you cash them in less than 5 years. For more information, go to Treasury Direct.

You might not think of using a CD as a place to keep your emergency fund, because CDs have maturity dates and charge you a penalty if you take the money out before then. But a strategy called laddering can make it work.

Say you have $5000 in your emergency fund. You could put $1000 in a one-year CD, another $1000 in a two-year CD, $1000 in a three-year, a four-year and a five year CD. If you have to take money out of a CD before the maturity date, you'll pay a penalty. But the penalty may be pretty small if the CD has almost reached maturity. If you have an emergency that costs less than $1000, you can break just one of the CDs, and you can choose the one that will charge you the lowest penalty. The remainder of your money keeps earning the nice CD interest rates. If you don't have an emergency, you renew each one into a five year CD when it matures. You've set up a rolling series of maturity dates, each now earning the higher rates earned by five year CDs compared to regular savings accounts or shorter CDs. You can check CD interest rates at

Your Emergency Fund may not look like much of a superhero right now, but with a little time, effort, and interest, it's powers will grow and grow.

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