Saturday, May 3, 2008

* Are There Cracks in Your Foundation?

So you think you are ready to start a little dividend investing? First let's do a quick home inspection and we'll start with the foundation. The foundation of any financial structure is an emergency fund. Life happens at the most inopportune times and it usually costs more than you anticipated. Below are some of the most pertinent Q&As related to an emergency fund:

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Q: What is an emergency fund?

A: An emergency fund is easily accessible cash to be used only in case of emergency. As defined by the American Heritage Dictionary.

e·mer·gen·cy: 1. A serious situation or occurrence that happens unexpectedly and demands immediate action. 2. A condition of urgent need for action or assistance: a state of emergency
Note: There is no mention of a better vacation, nicer car, home renovations, and other things we are apt to spend the emergency fund on.
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Q: I would like to get starting investing now, can I use my investments as my emergency fund?

A: No, you don't want to do that. Dividend investing is about buying good solid investments and holding them long-term (if not forever). If you are relying on your dividend investments as an emergency fund you may be forced to sell when the stocks are at their lowest. For example, the country goes into a recession, the stock market tanks, you are laid off from your job, you must then sell your stocks at record lows to feed your family.
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Q: How much should I have in an emergency fund?

A: The textbook answer is 4-6 months, and I don't disagree with that. In my case, I have 4 months since I could easily make lifestyle changes and extend the funds well beyond 6 months. You need to review your own situation and make that determination.
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Q: Where should I keep my emergency fund?

A: It should be readily accessible. A portion of it should be immediately accessible via check. My emergency fund is spread between high-yield online money market accounts, such as AmTrust and ING, and a portion of it is kept in an account that allows me to write checks. Currently, I am using Capital One as the account that allows me to write checks. Ironically, it is paying one of the highest rates, so I have my entire emergency fund there.
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You wouldn't want to buy or live in a house with cracks in its foundation. You need to make sure your financial house is built on a solid 4-6 month emergency fund.


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