Personal Finance: Creating an Emergency Fund

When life throws you a curve ball, you usually have two options: run and hide or take it in stride. Taking things in stride is your best bet, but it's far easier said than done. You need the right mind-set, plus a little preparation and planning. Having an emergency fund goes a long way towards lowering your stress level when you see that curve ball spinning towards you.

The Emergency Fundamentals

Any reputable financial professional will tell you that in today's era of business closures and lay-offs, it's a gamble not to prepare for an unexpected change in your income. The general rule of thumb is to set aside three to six months of living expenses. Conventional wisdom recommends parking that cash in a liquid fund, like a money market account.

There's another strategy, however, that can help you maximize the return on that cash. By combining a home equity line of credit (HELOC) and a certificate of deposit (CD), you can earn a higher return without losing the liquidity you need.

When you open a CD, you're locking away the money for a specified time period. Most investors begin with a shorter term, and keep rolling the money into a new CD at the end of each term. CD rates are higher than those of savings or money market accounts. But there is a trade-off-although you can withdraw the money before the term is up, you'll be charged a small penalty. However, if you need the money and you have a HELOC, you can avoid the penalty by taking a draw and repaying it when the CD becomes due.

CDs are offered by conventional banks, online banks, and credit unions. CD rates vary among financial institutions, so shop around and compare to get the highest return.

Be ready to take your best shot at that curve ball by establishing an emergency fund and managing it properly. When the time comes, you'll be glad you did.