Last week I linked to an article in the Arizona Republic, where I and several others offered tips and opinions regarding how to control spending.  A twist on that original article ran last Friday in the Money section of the Republic.  In both cases, one of the basic points is that simply controlling spending can have a significant impact on your financial well-being.

This is something I will come back to time and time again, but we’ve arrived at a point where the world of finance has become so complex that it feels to many people like it has simply moved beyond them.  In some cases, there may be some truth to that.  For most people, though, it still pays to keep things simple.  That may sound obvious, but our collective behavior over the last few years suggests that we have not been practicing it.

There are many areas of personal finance where embracing simplicity is beneficial, and I’ll explore others in future posts.  Today I want to emphasize the importance of the Emergency fund.  An emergency fund will allow you to cover significant unexpected expenses without disrupting your financial plan.  For instance, if you’re suddenly facing a $3,000 car repair that you hadn’t anticipated, instead of raiding your retirement savings, an emergency fund would be a more comfortable source.  In a more extreme but increasingly common case, such a fund can help you ride out a period of unemployment.

How do I build a fund?

Until recently, it had become relatively common for people to rely on a Home Equity Line of Credit (HELOC) to serve as an emergency fund.  The logic behind this was pretty solid, if implemented correctly.  It freed up cash to be utilized in a longer term, higher yielding manner.  The line could remain dormant and thus inexpensive as long as it wasn’t needed.  With the skyrocketing real estate market, the equity in the average person’s home was substantial.  Furthermore, if it did become necessary to tap the line, rates were typically pretty favorable.  Drawing on this resource would allow these individuals time to unwind other investments in an orderly manner to eventually pay down the home equity line.  It wasn’t the best scenario for everybody, but it was not a universally terrible idea, either.

All of that has changed.  Many homeowners have seen their HELOCs closed as the equity in their homes evaporated.  Others have maintained equity, but have had their lines closed, anyway.  Still others continue to have an accessible line, but should not have confidence that it will be there in an emergency.

That brings us back to the simple approach:  set aside some cash for use in an emergency.  How much?  The most common suggestion is 3-6 months of day to day spending, but it really depends on your individual situation.  I certainly think 6 months is better than 3, and I think in uncertain times like these it pays to increase that if it’s possible.  Just know that the cash you have set aside is, by definition, sitting in a low risk, low return account.

Where should I put my cash?

In this environment of low interest rates, it is very difficult to find a place to stash cash and feel good about it.  It may sound painful, but I think the easiest thing to do right now is to set aside these funds in a simple savings account.  There are several websites that allow you to compare rates among various financial institutions and find the best yield.  Perhaps the most well-known comparison tool on the web is Bankrate.com.  The two banks that I use for mortgages as well as my checking accounts are both household names.  I’m a pretty demanding banking customer, but I’m actually satisfied with both banks, and they have probably been the two that have stood the tallest through the recent crisis, at least among big banks.  However, their standard money market accounts are currently yielding .01% and .05% for Arizona residents, according to Bankrate.com.  In contrast, the site shows that HSBCDirect is offering an account that yields over 2.4% with a $1 minimum deposit.  Although I have not found it on Bankrate.com, Dollar Savings Direct offers an account that requires a $1000 minimum that it claims is the highest-yielding in the nation.  These are legitmate banks and the accounts are fully covered by the FDIC.  Note that Dollar Savings Direct is a division of Emigrant Bank, which itself has been known for a while as a leader in high-yield accounts.  Others that typically offer high rates via the Internet are E*Trade Bank and INGDirect.