3-6 months of living expenses?

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Personal-finance experts often recommend having 3-6 months' worth of living expenses saved and easily accessible. In his July 1, 2007 Getting Going column ("Popular Advice You Shouldn't Take"), Wall Street Journal columnist Jonathan Clements offers alternatives to a cash account (e.g., savings account or CD). He's got practical ideas that relate to how people really think, live, save, and invest.

Let's consider why experts make this recommendation so you can develop a personal-finance Plan B.

The primary reasons experts recommend cash reserves are 1) to pay for emergencies or unexpected, non-budgeted expenses such as medical bills or major home repairs 2) to pay regular expenses (e.g., your rent or mortgage, food) if you become unemployed, disabled, or lose income for some reason. They want you to avoid financial unpleasantness that may haunt you for years to come:

• Bad: you have to pay for emergencies using credit cards with high interest rates; you have to sell your mutual funds, ETFs, or stocks, during a market downturn.

• Worse: You have to pay tax penalties for withdrawing funds from your 401(k) or tax-deferred account.

• Catastrophic: you have to declare bankruptcy; you lose your house to foreclosure.

Try to prevent or calmly, wisely deal with financial emergencies:

• Don’t go a day without health insurance, especially now that the insured get discounts not typically available to the uninsured;

• Get an estimate of costs ahead of medical bills and start setting aside money before the bills are due (In my experience, healthcare providers are slower than other vendors in forwarding bills as they often wait for insurance reimbursement before requesting payments from consumers);

• Ask for a payment plan from vendors (When I was in my early 20’s, my dentist offered to let me pay a small portion monthly until my balance for extensive dental work was paid in full; my childhood dentist didn't believe in novacaine so I avoided dentists while in college);

• Buy disability insurance;

• Have your home inspected or do a home inspection yourself, figure out what items need to be replaced or fixed before they completely disintegrate, and start planning for major home repairs now;

• See if your homeowner’s or renter’s insurance can cover unusual expenses.

Note that there are scenarios where losing your job wouldn’t be financially catastrophic:

• You have a spouse/significant other who can cover regular expenses (which means, most likely, that you have purchased much less house or less car than you can afford by lenders’ standards or you have a high-earning spouse/significant other);

• You can adjust your living situation easily (e.g., move in with your parents while looking for another job or recovering from an injury);

• You work in a field and/or live in a market that makes finding a new job with pay comparable to your current one relatively easy (but if your company compensates you extremely well compared to its competitors, start socking away money now!)

In Popular Advice You Shouldn't Take, Mr. Clements suggests these alternatives to saving cash:

• fund your 401(k) to receive company matches and tax benefits;

• save some money in a conservative, taxable account;

• open, fund, and, if necessary, access contributions to a Roth account (your contributions can be taken out without tax consequences although earnings generated from the investments can not be used without penalty; see this article on the Roth)

• make a down payment on a home using funds you've saved by not having traditional cash reserves, and then

• take out a HELOC (home equity line of credit), which should carry a lower interest rate than a credit card.

Please know that Mr. Clements and I do want you to set aside money now for future use; we just want you to consider investing your money rather than putting funds in accounts with low returns. When you can enjoy the fruits of not spending (buying a home, getting company-match dollars, growing your portfolio), you'll be motivated to keep on saving and investing.

(edited for placement of link to Mr. Clements' article)