I talk to investors all the time, and I'm almost always impressed by their ability to focus on the future. People are tapping the opportunities of the financial markets to build wealth for long-term goals. Most investors are pretty diligent about reviewing their portfolios and making adjustments as situations change. But many of us fall short when it comes to taking care of the more mundane aspects of our financial lives, particularly when it comes to preparing for the unexpected.
A layoff, a serious illness or an injury could disrupt your normal income stream. An aging parent or an adult child might need your financial help in a hurry. A natural disaster might put a heavy short-term burden on your liquid assets. You can't foresee the unexpected, of course; however, you can prepare for it by building and maintaining a viable emergency fund, and by making sure you've got the insurance coverage that makes sense for you.
A STASH OF CASH
Your first line of defense should be an emergency fund. How much is up to you, but I agree with most personal finance experts that a good goal is to have from three to six months of living expenses stashed away in a very safe and liquid investment vehicle.
I realize that in today's world plenty of people can get cash when they need it; however, many of their liquidity options are bad ones. Cash advance on a credit card? High fees and the high cost of interest payments. Sell an existing financial asset like a stock or a mutual fund? You might have to sell during a downturn or you could be triggering tax liabilities. It's much better to keep some money on hand so you don't have to resort to these potentially expensive alternatives.
A home equity line of credit (HELOC) can be a great source of liquidity, assuming you own your home and you've established the HELOC before you need it. Most HELOCs can be tapped simply by writing a check - and there is a tax deduction - but make sure you understand the procedures and the potential costs before you need to access the credit. I'd still prefer to use existing cash over adding to my debt burden.
PUTTING YOUR EMERGENCY CASH TO WORK
When I say "cash" I don't mean hundred dollar bills stuffed into your mattress. Though if you live in an area with the potential for natural disasters, like floods, earthquakes or wildfires, it's wise to keep a few hundred dollars in cash at home. Your primary emergency fund should be safe and accessible, but that doesn't mean it can't be earning something.
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