Better plan now for emergencies

Unpleasant surprises, such as layoffs and major medical expenses, do occasionally rear their ugly heads. That’s why you need to have some emergency funds available. Conventional wisdom suggests that you sock away at least three to six months’ worth of living expenses. Here’s a short guide to emergency planning.

First off, don’t park emergency money in the volatile stock market, as anything can happen there in the short term. Bank savings accounts aren’t so hot, either, because they pay paltry interest. Instead, stash your cash in a money market fund. You might also park it in short-term certificates of deposit (CDs) or bonds, perhaps staggered so that a portion is always close to maturity.

You have some unconventional options, too. If you have little or no credit card debt, you might plan to charge emergency expenses on your credit card, up to a certain amount. Be very careful with this approach, though. If you’re charged a steep interest rate on a large balance, a bad situation can get much worse quickly.

Loans are another possibility. If you have family members or close friends who could easily lend you enough to cover your temporary needs, that could work out well. You might also be able to borrow what you need from your brokerage, on margin, with your portfolio as collateral. People usually borrow on margin to buy additional stock, but you can borrow for pretty much any purpose. Just be careful – if you borrow a lot and your stocks suddenly plunge in value, you’ll be hit with a “margin call” and may end up losing some of your stocks. Use margin sparingly, if you use it at all. As a last resort, you might be able to take out a home equity loan or borrow against your 401(k) account at work.

Unconventional alternatives can help you avoid keeping a sizable chunk of money tied up where it’s not earning much for you. But a more conventional approach, such as investing in CDs and money market funds, might be best and may help you sleep better, too.

Learn more about short-term savings at www.Fool.com/savings and www.bankrate.com.

Ask the Fool

Q: What should I do with stocks I bought near their all-time highs? Just sit tight? – T.M., Omaha, Neb.

A: The price you paid for the stock is important when you calculate your gain (or loss) for tax purposes. But most of the time, you shouldn’t think about it too much. What really matters is the current price and your estimate of the stock’s true fair price.

For example, imagine that you bought shares of Morse Code Telecommunications (ticker: TAPTAP) for $50 each, and they’re now trading for $30 each. If you think the shares are worth $40, you should probably hang on. If you think they’re worth less than $30, selling might be best. Ignore the fact that you’re down $20 per share. If you’d bought the shares for $10 each, you’d be up $20 per share, but your thinking should be the same – hang on if you think more growth is ahead, and sell if you expect the shares to falter.

Never hang on to a stock just in the hope of recouping your losses. You can always try to make your money back in another stock, perhaps one in which you have much more confidence.

Q: Before interest rates rise much more, I’m thinking of refinancing my mortgage. Where can I learn more about that? – A.C., Wichita Falls, Texas

A: Refinancing is still worthwhile for many people. Learn all about home financing issues at www.quicken.com/mortgage /refinance and www.fool.com/homecenter.

Grab your 15 minutes of fame and ask a financial question of Fool co-founders David and Tom Gardner on The Motley Fool Radio Show on National Public Radio. Call anytime toll-free at 866-NPR-FOOL.

My dumbest investment

While still a teenager, I returned from the Army in 1947. I bought bargain surplus Alcoa aluminum sheet metal and built four boats, making some money. I could also have bought Alcoa common stock. But I reasoned that such investments, with their silly little dividends, often in pennies per share, were for old grandpas. Now I understand investing better and realize that about $400 invested in Alcoa in 1947 might very well have been a good thing for an old grandpa today. – H.R. Wenger, Kansas

The Fool Replies: Right you are. Dividends do often seem puny, but they add up over time and even generally get increased now and then, too. Alcoa, for example, increased its annual dividend by a full 20 percent in 2002. Shares of Alcoa have advanced more than 10,000 percent in the past two decades – not bad for what some consider a sleepy stock. Aluminum may not be as exciting as fields like biotech and telecommunications, but it’s needed for everything from planes to houses to soft drink cans.