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Saving money for an unexpected expense
There are several important reasons to save money, such as a “rainy day” fund for an unexpected expense like a home repair or automobile repair, specific anticipated expenses like Christmas gifts or an upcoming vacation, or a few months’ worth of “living” money for an unanticipated job loss or disability. This money should be separate from your investments, as investments can decrease in value at precisely the time you may need money from them. When you save, you’re “tucking money away” in case–or when–you need it.
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The reason why cash alternatives are at the foundation of a well-balanced portfolio is that cash alternatives allow you to meet short-term and unpredictable expenses. Having cash and cash alternatives also may allow you to manage other investments — rather than selling at what could be an inopportune time.
Keep in mind that allocating your assets among different investments is an approach to help manage investment risk. It does not eliminate the risk of loss if security prices decline.
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Where to Put the Money
For that portion of a portfolio that must be liquid, most investors consider one or more of four places. Each has drawbacks and advantages.
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Savings
bank savings accounts
Certificates of Deposit
time deposits
Money Market
investment funds
Treasury Bills
debt-based instruments
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Traditional bank savings accounts (savings, checking), are both guaranteed, up to certain limits, by the FDIC. However, traditional bank account returns are modest at best.
Certificates of deposit, on the other hand, are time deposits offered by banks, thrift institutions, and credit unions. They may offer a slightly higher return than a traditional bank savings account, but they also may require a higher amount of deposit.
Money market funds are investment funds that seek to preserve the value of your investment at $1.00 a share. Money held in money market funds is not insured or guaranteed by the FDIC or any other government agency. It’s possible to lose money by investing in a money market fund.
Treasury bills are actually debt-based instruments — investors lend money to the government and are paid a specific rate of return. Treasury bills are backed by the full faith and credit of the federal government as to the timely payment of principal and interest.
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How Much Do I Need
At any stage in life, it is wise to reserve enough cash on hand to cover your expenses in three areas:
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Replace Income
First, you should be able to replace your income for a short period of time in the event of job loss or a loss of investment income. A good rule of thumb is to have enough on hand to replace your income for three to six months.
Emergency Allowance
Second, you should make allowance for emergencies that may occur, such as a catastrophic illness or an accident.
Upcoming Expenses
And third, you should have some cash on hand for upcoming large expenses, such as a wedding or an extended vacation.
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At the end of the day, the key to financial happiness is not always about having more money. The key is to manage the money you do have well. We can help you do that.