Rule of thumb may leave too little - or too much - cash on hand

Three to six months. That is part of what is known as a rule of thumb. In this case, it is supposed to be the answer to how much cash an individual or family should have on hand to cover emergencies. The rule says you should have three to six months' take-home pay in a place where you can get to it easily, like a savings account or money market mutual fund.

Like most rules of thumb, this one doesn't work for everybody, but everybody should take some time to figure out just how much is right for them.

``There are a lot of rules of thumb around,'' says Michael E. Leonetti, a financial planner in Buffalo Grove, Ill. ``Some of them are useful.''

In a recent article in the Journal of the American Association of Individual Investors, Mr. Leonetti discussed some methods for finding out how liquid you should be, that is, how much money you should have on hand.

Your occupation is an important piece of the answer, Leonetti says. ``People who depend on commission-based income should have a lot more set aside,'' he says. This might include real estate agents, financial advisers who rely on commissions (as well as fee-only planners), and commission-based salespeople.

Like many financial exercises, the first step in figuring out liquidity needs is to carefully examine income and outgo. You can start by making a worksheet that lists all sources of income received by everyone in the home, including the husband's and wife's salary, child support, alimony, dividend and interest income, trust income, pension income, and social security payments. To get the best picture on a monthly basis, Leonetti suggests doing this for each of the past 12 months.

The next step is to list all expenses, including loan payments, clothing, rent or mortgage, insurance, food, withholding and other taxes, retirement savings, and business expenses. Again, these should be separated for each of the last 12 months.

Putting these two worksheets together should give you a sense of your cash flow needs on a month-to-month basis.

Now you'll need to figure out how to replace that income to meet those expenses. If the job loss is because of an injury, disability insurance should cover most of your income needs, assuming you have this type of insurance. But most of these policies don't begin making payments immediately; there is usually a waiting period of a few months. You can buy disability coverage with very short waiting periods, but the premiums are much higher, so it might be better to put that extra money in the savings account.

To get you through this waiting period, your employer, if you have one, may continue all or most of your salary and benefits. The length of coverage will depend on company policy and probably your length of employment there, so this would be a good time to ask your personnel manager where you stand here.

The loss of income may also be the result of a job loss due to firing, cutbacks at work, or a corporate restructuring that leaves you without a job. Depending on the cause of unemployment, this may be partially covered by severance pay and/or unemployment insurance. Here again, you can talk to your employer about your company's participation in the state unemployment insurance program and contact the unemployment office to get a general idea of how much your unemployment insurance would be.

This, like the payments from disability insurance, can then be added to the income portion of your worksheet and compared with the expenses side. This will give a clearer picture of the potential shortfall on a monthly basis.

Of course, if you do not have disability insurance or your employer does not participate in the unemployment insurance program, you should regard the equivalent of six months' salary in savings as a minimum. How much more will depend in part on your skills, how transferable they are, and your confidence in your ability to find a new job if you lose your old one.

Job security and future prospects are not the only reasons for keeping some liquidity. Unforeseen emergencies, such as a broken water heater, major car repairs, and home repairs should also be considered; so should the deductibles for various types of insurance.

Like most other experts, Leonetti defines liquidity as assets that can be turned into cash immediately without a potential for loss. This would include checking and savings accounts and money market funds, but not stocks, bonds, certificates of deposit, or other investments that could cost you money if they were sold or cashed in prematurely.

Another source of funds Leonetti calls ``negative liquidity'' should be used very carefully. This is the unused lines of credit on credit cards like Visa or MasterCard. If you have little or no outstanding balance on your credit card, you may be able to take it into a bank and get a cash advance to cover immediate needs. This might make sense, for example, if you have a CD maturing in a few weeks or you plan to sell some shares of stock about that time. So the cash advance could be used in the interim.

Since cash advances can lead to even more severe financial trouble, however, be sure you see a future source of funds coming - like a new job or an imminent return to work - before resorting to this.