In times of crisis, you don’t want to be shaking pennies out of a piggy bank. Having a financial safety net in place can ensure that you’re protected when a financial emergency arises. One way to accomplish this is by setting up a cash reserve, a pool of readily available funds that can help you meet emergency or highly urgent short-term needs.
As part of our comprehensive financial planning process, we separate clients’ money into two buckets: One for their long-term goals and one for their short-term income and liquidity needs. This accomplishes two important things. First, it ensures that short-term needs are met. Second, knowing that short-term needs are taken care of can help people become more patient long-term investors.
In any event, having a rainy day fund for emergency expenses is an important financial goal in and of itself.
How much is enough?
We suggest that you have three to six months’ worth of living expenses in your cash reserve. The actual amount, however, should be based on your particular circumstances. Do you have a mortgage? Do you have short-term and long-term disability protection? Are you paying for your child’s orthodontics? Are you making car payments? Other factors you need to consider include your job security, health and income.
The bottom line: Without an emergency fund, a period of crisis – such as unemployment or disability – could be financially devastating.
Building your cash reserve
If you haven’t established a cash reserve, or if the one you have is inadequate, you can take several steps to eliminate the shortfall:
- Save aggressively: If available, use payroll deduction at work; budget your savings as part of regular household expenses
- Reduce your discretionary spending, such as eating out or going to movies
- Use current or liquid assets (those that are cash or are convertible to cash within a year, such as a short-term certificate of deposit)
- Use earnings from other investments, such as stocks, bonds or mutual funds
- Check out other resources. For example, do you have a cash value insurance policy that you can borrow from?
A final note: Your credit line can be a secondary source of funds in a time of crisis. Borrowed money, however, has to be paid back – often at high interest rates. As a result, you shouldn’t consider lenders as a primary source for your cash reserve.
Where to keep your cash reserve
You’ll want to make sure that your cash reserve is readily available when you need it. However, an FDIC-insured, low-interest savings account isn’t your only option. There are several excellent alternatives, each with its own advantages. For example, money market accounts and short-term CDs typically offer higher interest rates than savings accounts, with little (if any) increased risk.
Note: Don’t confuse a money market mutual fund with a money market deposit account. An investment in a money market mutual fund is not insured or guaranteed by the FDIC. Although the mutual fund seeks to preserve the value of your investment at $1 per share, it is possible to lose money by investing in the fund. Note: When considering a money market mutual fund, be sure to obtain and read the fund’s prospectus, which is available from the fund or your financial advisor, and outlines the fund’s investment objectives, risks, fees, expenses. Carefully consider those factors before investing.
It’s important to note that certain fixed-term investment vehicles (i.e., those that pledge to return your principal plus interest on a given date), such as CDs, impose a significant penalty for early withdrawals. So, if you’re going to use fixed-term investments as part of your cash reserve, you’ll want to be sure to ladder (stagger) their maturity dates over a short period of time, such as two to five months. This will ensure the availability of funds, without penalty, to meet sudden financial needs.
Review your cash reserve periodically
Your personal and financial circumstances change often – a new child comes along, an aging parent becomes more dependent or a larger home brings increased expenses. Because your cash reserve is the first line of protection against financial devastation, you should review it annually to make sure that it fits your current needs.
We can help you identify how much you should have set aside for the unexpected as part of our financial planning process. To learn more, contact one of our advisors today.
*Past performance is not an indicator of future results. This material is not financial advice or an offer to sell any product. The statements contained herein are solely based upon the opinions of Elevage Partners, LLC (“Elevage”). Elevage is a registered investment adviser. More information about the firm can be found in its Form ADV Part 2, which may be requested by calling (877) 922-8243 or visiting http://www.adviserinfo.sec.gov. The information contained herein is derived from sources we believe to be reliable, but which we have not independently verified. Elevage assumes no responsibility for errors, inaccuracies or omissions in this information. Elevage reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs. The information provided in this report should not be considered a recommendation to purchase or sell any particular security. There is no assurance that any securities discussed herein will remain in an account’s portfolio at the time you receive. It should not be assumed that any of the securities transactions, holdings or sectors discussed were, or will prove to be profitable, or that the investment recommendations or decisions Elevage makes in the future will be profitable or will equal the investment performance of the securities discussed herein.ELV-17-02