Building Up Your Cash Cache

When the National Foundation for Credit Counseling in Washington, D.C., conducted its 2012 Consumer Financial Literacy Survey this spring, the results were sobering. The number of Americans saving for a rainy day had dropped significantly.  When asked, “Do you have any savings, excluding retirement savings?” Thirty-nine percent of respondents answered no. “That’s the highest percentage since we began asking in 2008,” says Gail Cunningham, NFCC spokeswoman, “and a 6% jump in just one year.”

Plagued by recession, high unemployment or underemployment, and rising living costs, Americans just aren’t saving the way they used to, says Camille Winfrey, financial solutions adviser with Merrill Edge in Atlanta. A situation can become dire when an emergency such as a car repair, medical bill, or other expense rears its ugly head. For most, the only way to address such needs without stealing from the “living expense” pot is by having a separate, emergency fund. “You don’t want to go into debt over a $500 car repair bill,” says Winfrey, “yet that’s often what happens when people have no cash reserves.”

Two years ago, Tammy Perry exhausted her savings, roughly $7,500. The 34-year-old Perry had just moved to New York City from Montgomery, Alabama, where the cost of living had been lower and she earned $2,000 more per month. Perry left her full-time job as a career counselor with the state of Alabama to start a business. She is now the owner of a training and education consultancy, Stockroom2Boardroom.

“I had no emergency fund left because I spent it all on living expenses,” says Perry. To get back on track, she began working with financial adviser Lynesha McElveen of Liberty Educational Group. The first step was to reduce unnecessary expenses, such as a full-featured cellphone data plan (changed to a prepaid option) and home cable service (switched to Netflix for $15 per month). Perry put the extra money in her emergency fund, held in an interest-bearing savings account.

“One year later I had $1,000 in that fund,” says Perry, who began allocating 3% of her

income to it. “By year two I was saving almost $2,000 per year.” The goal is for Perry to shore up at least three months’ worth of living and business expenses, or $12,000, and to leave that money untouched.

Winfrey says most people can get away with maintaining three to six months’ worth of expenses in an emergency fund, but notes that those dealing with job uncertainty or income fluctuations should consider a six- to nine-month timeline.

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Other key considerations include the number of income earners in the household (the fewer there are, the higher your reserve timeline should be).

One of the best ways to get started is to funnel a set amount from your paycheck into a savings account or short-term investment option. Ten percent of every paycheck is a rule of thumb, but don’t be afraid to start small, for instance, 3%, and then work your way up to that ideal amount.

“I encourage people to be aggressive during the funding phase,” advises

Robert Gordon, senior financial adviser at Investor Solutions in Miami. “Ten percent from every paycheck may hurt at first, but if you’re not aggressive you won’t reach your goal.” Treat your emergency fund like a bill you pay each month. Also, see it as a kind of insurance against unexpected expenses, not as a source to tap when you want to go shopping or out to dinner.

With savings rates hovering in the 1% range, getting a good return on an emergency fund–which has to be accessible–isn’t easy. Once a few months’ reserve is saved, Winfrey suggests keeping one month’s worth in an interest-bearing account (for quick access) or a high yield money market account and the rest in short-term CD options.

Include laddered CD portfolios, whereby you invest in CDs with various maturity dates ranging from three months to six months to a year, and that are renewable if the money isn’t immediately needed. “When you use this approach you’ll earn a little bit better than the cash rate of return,” says Gordon, “but you’ll still have access to the money on a rolling basis.” Check Bankrate.com to find the best CD rates nationwide.

Short-term bond mutual funds, which typically have maturity dates of two years or less, are another good option. Look for funds with A, AA, or AAA ratings, says Gordon, who suggests allocating an emergency fund as follows: 1/3 to a regular savings account, 1/3 to a laddered CD portfolio, and 1/3 to short-term bond mutual funds. “You’ll have enough liquid funds to cover emergency expenses,” he says, “and the rest will be earning somewhat higher rates of return while still offering safety and liquidity.”

Perry says rebuilding her emergency fund is well worth the pain of allocating a percentage of her paycheck to the cause. “When you’re in a lifestyle where there’s no ‘extra’ money and your accounts hover around negative territory, it’s frightening,” she says. “I went from having no buying power to having control over my finances. It’s been a real blessing.”