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Where to Turn for Emergency Cash, Part II

Christine Benz is Morningstar's director of personal finance and the editor of the Morningstar PracticalFinance newsletter. She is also the author of the second edition of the Morningstar Guide to Mutual Funds: 5-Star Strategies for Success. Although she reads every e-mail she receives, she cannot respond to each message individually or provide individualized portfolio advice. Meet Morningstar's other investing specialists.

With the headlines screaming fresh news about job losses, ongoing housing-market woes, and sky-high prices at the fuel pump, I guess I shouldn't have been surprised that my recent column about where to go for emergency cash prompted a large response from readers. Many of you wrote with comments and questions, and others pitched in with additional ideas that I hadn't covered in my article.

Because the topic of where to turn for emergency funds is a broad one, I'll use this article to address some of the points that I didn't cover last week.

The Right Investments for Your Emergency Fund
In my previous column, I noted that the best source of cash for unanticipated financial needs is your own emergency fund. That prompted several readers to ask where they should keep their cash.

Because you won't know in advance when you'll need to tap your emergency-fund assets, you need to invest in securities that will ensure a steady principal value: CDs or a money market account or fund. You can also count other liquid assets--such as the amounts that you hold in your savings and checking accounts--toward your emergency fund, as long as you're not committing these assets toward other uses.

I know, the emergency fund isn't a small pool of assets, so it's tempting to want to reach for a higher yield by venturing into an ultra-short-term or even a short-term bond fund. I'd urge caution on this front, however. Some funds that investors may have considered just a step up from a money market vehicle have posted extreme losses amid the subprime crisis, with Schwab YieldPlus (SWYPX) the poster child for just how bad things can get. (The fund has lost a shocking 28% of its value for the year to date.) While an implosion of that magnitude is unusual, you can't count on a stable net asset value with ultra-short- and short-term bond funds, and the funds delivering the most tempting yields may also be taking on outsized risks to deliver their payouts.

My advice is for everyone to keep a minimum of three to six months' worth of living expenses in CDs and money market accounts or funds. If you decide that your emergency fund should be larger--either because your employment picture is unstable or you have a high income that could be tough to replace in case of job loss--it's probably OK to put those additional assets in something with a little more yield potential. In this vein, a couple of my favorites include Vanguard Short-Term Tax-Exempt
(VWSTX) and Vanguard Short-Term Investment-Grade (VFSTX). (By all means, opt for municipal securities for your emergency fund if you'll earn a higher aftertax payout.) For some dos and don'ts of where to park your short-term cash

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