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Money can smooth over many of life’s unexpected difficulties. At some point, we all need quickly accessible cash to cover sudden medical bills, to pay the mortgage between jobs, or to repair flood damage from a broken water line. At some point, we all need an emergency fund. As common-sense as this sounds, building an emergency fund is not a universal practice. According to a 2001 survey by Fidelity Investments, 41 percent of U.S. households lacked any savings for sudden trouble. Moreover, those living without a net may not just be the struggling poor. According to a survey released this March by CareerBuilder.com, 19 percent of those who earn more than $100,000 often or always live paycheck-to-paycheck. What are the odds that those people have set aside solid emergency funds? There is no debate over whether you should have an emergency fund: You definitely should. But there are important questions (and even some debate) about how much to put in the fund and about where you should keep it. And those of us living in terrorist target zones, such as Washington, D.C., should consider devoting a portion of those funds to securing some especially primal emergency needs. HOW MUCH? So how much do you need? Enough to tide you over until the emergency ends. The usual advice is that your emergency fund should cover three to six months’ worth of living expenses. But some are skeptical about this conventional wisdom. They reason that keeping six months’ worth of living expenses, potentially a significant percentage of a small portfolio, is holding too much money in low-yielding investments. Just a month or two of living expenses, the argument goes, is sufficient: If the problem lasts much longer, you can always get money from other sources, such as retirement savings, loans, disability insurance, etc. The question of how much to save also depends on your personal circumstances. If you’re a single person, or half of a two-income couple, with reasonable living expenses and no dependents, you arguably have less financial exposure to sudden disaster than does a primary breadwinner with multiple children. If you’re supporting a stay-at-home spouse and three teenagers, you probably have more exposure to risk — more people to fall ill, more cars to crash or break down, and so forth — and no cushion in the form of a spouse’s salary. Your temperament also comes into play. Personally, I keep a full year’s worth of living expenses in cash reserves. Is this unusually cautious? Sure. Is it the optimal way to structure your portfolio? Most computer models would indicate not. But it gives me comfort to know that even if somehow I lost my job, broke both my legs, and saw the stock market tank all in the same week, I would still be OK. However much you decide to keep in your emergency fund, remember to view the fund in conjunction with your other available sources of ready cash. Sometimes people make mistakes with their “mental accounting”: They tend to view money in separate categories and not focus on how it’s fungible. For instance, they’ll keep an emergency fund in a money-market account earning 5 percent at the same time they’re paying 15 percent in interest on credit-card debt. That’s probably not wise: They could pay down the credit-card debt with the savings, escape the high interest charges, and still have the credit cards available for any emergency that arises. In effect, unused credit, including both credit cards and home-equity lines, can work as an emergency fund, albeit one that would charge interest. WHERE TO KEEP IT Now you’ve looked at your needs, your risks, your temperament, and your credit lines, and arrived at a figure for your emergency fund. The next step is deciding where to save your emergency cash. You have three goals: Keep the funds liquid — this is an emergency, you need the money now, and the mortgage bank won’t accept a time share in your Saab. Keep the funds relatively safe from market fluctuations — no high-risk stocks that plummet in value two days before your auto accident. And keep your money breaking even after taxes and inflation — why cash under the mattress is a bad idea. That last problem is often overlooked. It’s very easy to lose purchasing power on the money in your emergency fund. That’s partly why some advisers want to limit the amount of money people keep in it. If you put your emergency funds in a checking account, they will be easy to access and quite safe, up to the Federal Deposit Insurance Corp.’s guarantee of $100,000. But they will earn either nothing or, in an interest-bearing checking account, not much. If you’re earning 1 percent a year on the checking account, an annual inflation rate of 3 percent will cause you to lose money in real terms. That problem becomes even worse when state and federal taxes are considered; your marginal tax rate on that interest income, depending on your bracket, could be more than 40 percent. Money market funds, sold by mutual fund companies, offer higher returns than checking accounts — perhaps around 5 percent currently. But check-writing can be limited, and there’s no FDIC guarantee, which means it is possible though probably unlikely for the fund to “break the buck” and lose money. And many banks, especially some that use the Internet in lieu of costly branches, offer high-interest (now 4 to 5 percent) savings accounts, which allow access to the money within a few days and also carry the FDIC’s guarantee. Bankrate.com can give you a variety of options for these various accounts. You may also want to consider Series I savings bonds from the federal government. These provide a real (i.e., after inflation) return — only 1.3 percent currently, though it’s been much higher in the past — and taxes are deferred until the bond is redeemed. The catch is that there’s a one-year waiting period between purchase and possible redemption. So you need to be able to cover any emergency in the first year with other funds. WATER FOR THE DESERT Most of an emergency fund belongs in interest-earning financial investments where you can get to it when an emergency hits you or your family. But perhaps the scariest emergencies — think Hurricane Katrina — hit the entire community. The fallout from those types of emergencies, particularly those that could hit people in or near a high-target city like the District, may not be easily remedied with money market accounts. Some people like to pay for most things with credit or debit cards, and others just don’t like to carry much cash on their person. But what happens when the credit card machines and the ATMs aren’t working, and the guy selling gas won’t take a check of any kind? I think it’s wise to have at least $200 to $300 per person squirreled away somewhere. You might also want to invest some of your emergency funds in emergency supplies. The Federal Emergency Management Agency recommends preparing a basic emergency kit for the home, stored in an easily carried container. The kit should contain food and water for three days, first aid supplies, bedding and sanitation gear, certain tools, and any special needs such as prescription medications. You can find so-called 72-hour kits for sale online, with prepackaged supplies designed to bring a person through the first three days of an emergency situation. Such a kit is a decent start (and probably the minimum that anyone should feel comfortable with). But perhaps because I’m both risk-averse and an Eagle Scout, I confess a certain fascination with those who go even further in preparing for adversity. For example, the Church of Jesus Christ of Latter-day Saints (the Mormons) recommends that its members store a year’s supply of food for each family member. Emergencies are going to happen. And when they do, the Boy Scouts were right: It’s best to be prepared.
Robert L. Rogers, associate opinion editor at Legal Times , writes the Legal Tender column on personal finance. E-mail Rob with comments or suggestions for future columns.

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