ASK KIM
Best Bet for Emergency Funds
by Kimberly Lankford

Where's the best place to save money for an emergency fund -- a tax-exempt money-market fund or a regular savings account that pays slightly higher interest? And how much money should I keep in the emergency fund?

The rule of thumb is to keep three to six months of living expenses in your emergency fund. Notice I said living expenses, not income, which could be a significant difference.

You may be able to slide by on the lower end of that scale if you have a secure job or already have a low-interest home-equity line of credit. But don't consider financing emergencies with credit cards or retirement savings. Such planning could land you deeply in debt, lead to a hefty tax bill or both.

Your savings will need to be safe and accessible, which makes money-market accounts or money-market funds with check-writing privileges your best bet. Search for the best rates at our Yields and Rates page (scroll down for money-market rates).

Barbara Steinmetz, a certified financial planner in Burlingame, Calif., is currently recommending Vanguard Prime Money Market (VMMXX) or Vanguard California Tax-Exempt Money Market (VCTXX) for California clients in a high tax bracket.

To figure out if a tax-exempt fund is better than a taxable account, divide the fund's yield by one minus your tax bracket. For example, let's say you're in the 25% tax bracket and are interested in tax-free fund paying a 1.03% yield. Subtract your tax rate from one (1 - 0.25 = 0.75), then divide that number into the tax-exempt fund yield (1.03/0.75 = 1.37). A taxable account would have to pay more than 1.37% to do better than a 1.03% tax-exempt money market fund.