There’s more than one way to save for an emergency

What’s Your Emergency Plan?

Let’s face it – life delivers some nasty blows. If you get laid off or face major medical expenses, you’ll need to have some emergency funds available. Conventional wisdom suggests socking away three to six months’ worth of living expenses, but you might need more – if, for example, you expect to take a long time to find a new job. Here are some emergency planning tips.

First, don’t park emergency money in stocks, as anything can happen there in the short term. Bank savings accounts aren’t so hot, either, offering paltry interest. Money market funds and bonds offer better rates. You might also use short-term CDs, perhaps staggered so that a portion is always close to maturity.

You’ve got some unconventional options, too. If you have little credit card debt, you might plan to charge emergency expenses on your credit card, up to a certain amount. Be careful with this approach: If you’re charged a steep interest rate on a large balance, a bad situation can get worse quickly.

If you have family members or friends who could easily lend you enough to cover your temporary needs, that could work out well, too. 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. Note, though: 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 help you sleep better.

Learn more about short-term savings at www.fool.com/savings.

Ask the Fool

Q: What is a “highly capitalized” company? – G.R., Baton Rouge, La.

A: It can be one that’s asset-heavy, overloaded with unproductive assets such as cash. Lots of cash is generally good, but if it’s just sitting around unused, that’s not ideal. In fact, if a company has nothing better to do with the money, it might as well pay it out to shareholders as a dividend, or use it to buy back (and essentially retire) some shares.

The term might also suggest that the firm’s market capitalization is too high. Market cap is the total price tag the market slaps on a company, calculated by multiplying the current share price by the total number of shares.

Q: Which brokerages charge very low trading commissions? – O.N., Dover, N.H.

A: A typical investor will pay $10 to $13 per trade at E*Trade, Fidelity, Charles Schwab and TD Ameritrade. It’s $7 at Scottrade and Firstrade, and you can find even lower rates elsewhere. Look at more than commissions, though. For example, if you buy or sell stocks only four times a year, finding the lowest commission rate won’t save you all that much. Meanwhile, some brokerages charge quarterly account fees just for having an account with them. These are often waived if your account is large enough, but if it isn’t, you may be forking over more than $100 per year. Look at all fees a brokerage charges, and consider what conveniences it offers (local branches, perhaps, or a wide variety of mutual funds, or check-writing services) and how well it meets your needs.

For comparison data on brokerages, visit www.broker.Fool.com or go to the library and read SmartMoney magazine’s annual brokerage review in its August issue.

My dumbest investment

My dumbest investment was, without a doubt, 360 Networks, to the tune of $6,200. I bought even more on its way down. I was hopeful about fiber-optic cable being the next big thing, but sometimes these things take time to develop. I learned a valuable lesson, though. Now I won’t invest in any company that is not up and running and making money. You may miss some flyers, but you will also miss a lot of pain! – Neil Meints, Jasper, Alberta, Canada

The Fool Responds: That’s an excellent rule to have. Many people get lured into poor investments by the stories surrounding them: This company is going to cure cancer, or that company has an exciting new technology. But such companies may not have enough money to last them while they establish themselves. And they may fail to snag the deals they need. And their products might not perform or be embraced as expected. It’s usually good to steer clear until a company has a proven track record of growing revenues and profits, a healthy balance sheet, and effective management.