Basic Principles of Investing

Emergency Funds

What If You Have an Emergency and Just Don't Have Enough Money in Liquid Assets?

It's important that you start to develop cash reserves. But you can't plan emergencies. So, here are some alternatives if you suddenly need money:

  • a home equity loan or line of credit (you should establish this now if you think you will need it in the future)
  • cashing in investments
  • a loan on a margin account (if you own securities)
  • a loan from a cash-value insurance policy
  • a personal loan from your bank or credit union
  • a loan from your 401(k) plan (NOTE: The unpaid balance is payable in full when you leave the employer.)
  • Credit cards (least favorable)

Which you should select depends on your own situation. Choose whatever borrowing method has the lowest effective interest rate. The reason you shouldn't count non-cash investments as emergency funds is that they can fluctuate in value. Emergency funds, by definition, should be there when you need them. And you should have a very good idea of what their value will be. You can't do that with stocks and bonds and real estate.

IMPORTANT NOTE: Some planners recommend keeping part of your emergency reserves of liquid assets in short-term bond funds—bonds having maturities less than three years. But be aware that a sudden rise in interest rates can lower the value of your principal in the fund. Even short-term bond funds can fluctuate in value. So limit the amount of money you keep in these funds that you may need to quickly to convert to cash.

If you know that you don't have enough in emergency funds, but you do have good credit, this might be a good time to establish a line of credit which you can draw on in the future if you need to.

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