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Question:


What is an acceptable amount of liquid assets to have prior to investing? Six months of living expenses? One year? Two years?
-Linda


Answer:


The rule of thumb is that you should save six months’ worth of income in case you lose your job, incur an unanticipated medical expense or suffer some other hardship. While it might seem even more prudent to place more than that in an emergency fund, it could be counterproductive. A savings account pays next to nothing these days unless you want to tie up the money for a year or more. But if you do that, you’ll be defeating the purpose of an emergency fund. Why not try something that amounts to a middle ground between saving and investing? Once you have put six months’ worth of income into a savings account, consider making regular contributions to a mutual fund that holds high-grade, short-term bonds.
 
Such a fund entails virtually no risk, and while some management companies charge a penalty for selling fund shares before 90 days, this wouldn’t affect you because you wouldn’t need the cash for at least six months. In the meantime, before an emergency comes along, the money will be earning one percent or two percent a year. That’s not much, but it’s better than a few hundredths of a percentage point, and it gets you in the habit of investing. Perhaps after you’ve set aside another six months’ worth of income in such a fund, you can try something that’s a little riskier but offers the potential for higher returns, such as a longer-term bond fund or a blue-chip stock fund.
-Conrad de Aenlle



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