Short-Term Savings

When we think of saving and investments, we often default to long-term thinking. But some of the money you sock away should be for the short term — particularly for possible financial emergencies. If a medical crisis, costly car expense or a job loss unexpectedly occurs and you’re not prepared with sufficient short-term savings, you may end up wiped out, or even in bankruptcy. For emergencies or known upcoming expenses (such as vacations and weddings), you have two main choices: 1) Save up and earn interest, or 2) Borrow the money (often via a credit card) and pay interest (at a much higher rate). Clearly, saving is better. Generally, aim to have at least three to six months’ worth of living expenses in an emergency fund. If it’s easy for you to find work, three months’ may be enough. If it’s not so easy and you’re supporting four kids, two elderly parents and six arthritic dogs, you may want to aim for a year’s worth of expenses. Beyond your emergency fund, any funds you’ll need within three to five years (or longer, to be more conservative) shouldn’t be in stocks. Stocks are perfect for long investment periods, but in the short run, anything can happen. Remember, for example, 2008’s 37 percent drop in the S&P 500. A crash occurring just before you have to make a big college tuition payment can spell disaster. Short-term savings belong in instruments such as savings accounts, money market accounts, certificates of deposit (CDs), shortterm government and corporate bonds and bond mutual funds. Interest rates are quite low these days, but they’ve been inching up. CD rates vary, in large part depending on how long you’re willing to tie up your money. Corporate bonds tend to pay more than CDs or Treasury bonds, depending on the risk of the bond. Some savings accounts were recently paying around 2 percent, while some three-year CDs offered 3 percent and some corporate bonds offered 4 percent or more. Learn more about short-term savings and find good interest rates at fool.com/savings and bankrate.com.