Frequently Asked Questions 1. Why do I need short-term savings?
Well, you could live off of your credit card if you lose your job, but then you get to pay back your shortsightedness at 18%. Many families have found themselves in bankruptcy as the result of just such a plan. You may not know exactly what is going to happen, but bad stuff happens often enough that you need to be ready when fate hits you in the face.

You also need to save up for foreseeable expenses. Vacations, new cars, and weddings are all predictable. You have got two choices: 1) save up and earn interest, or 2) borrow the money and pay (at a much higher rate) interest. Seems like a no-brainer.

2. How much money do I need in short-term savings?
Well, that depends on your situation -- not that we are weaseling out of an answer, but there is no formula that fits all cases.

Generally, you will want to have at least three to six months of living expenses in an emergency fund in the event that fortune frowns on you in one of its many, many ways. How much you need depends on your financial responsibilities. If you're a programmer who is footloose and fancy free, a couple of month's worth may be enough. If you are a performance artist who is the sole support of six children and your aged parents, you will probably want to aim for a year's worth of expenses in ready cash.

Beyond your emergency fund, any funds you will need within three to five years should not be at risk in the stock market.

3. Why shouldn't I just keep all my savings invested in stocks?
We are the biggest supporters of the idea that all of your long-term money should be invested (stock market, real estate, your own business, etc.). However, over the short term, these investments are too volatile for short-term savings. Buying stocks for short-term gain is really speculating, not investing. Would you have wanted to have your emergency fund, or your house down payment, or your kid's tuition in the Nasdaq at its height on March 10, 2000? If you can't afford or can't wait out a 30% drop in the value of your savings, keep it out of the market.

4. What can I invest my short-term savings in?
Something boring. There are a wide variety of instruments for your short-term savings, including money market accounts, certificates of deposit (CDs), government and corporate bonds, and bond mutual funds. We cover these different choices in greater depth in Saving Options.

5. What kind of return can I expect to get?
Your return will vary, of course, but right now money market accounts are paying 3% to 5%. CD rates depend on how long you are willing to tie up your money, but short-term CDs start out about the same as money market rates and go up in small increments as the term gets longer. Corporate bonds tend to pay more than CDs or Treasury bonds, depending on the risk of the bond. You can get a great interest rate on companies that are heading toward Chapter 11! (Not surprisingly, this isn't a strategy we would recommend.)

Compared to the average return of the stock market, real estate, or your own business, your return on your liquid savings won't be very impressive.