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.
How much is enough?
Most financial professionals 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 (e.g.,
unemployment, 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 (e.g., eating out, movies, lottery tickets)
- 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 (e.g.,stocks, bonds, or mutual funds)
- Check out other resources (e.g., 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 unique 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 (e.g., 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.
Securities offered through IFP Securities, LLC, dba Independent Financial Partners (IFP), member
FINRA/SIPC. Investment advice offered through IFP Advisors, LLC, dba Independent Financial
Partners (IFP), a Registered Investment Adviser. IFP and Hitchcock Maddox Financial Partners are
not affiliated. This is for educational and informational purposes only and is not research or a
recommendation regarding any security or investment strategy. Investing involves serious risks and
past performance is no guarantee of future performance or success. This is not an offer to buy or sell
securities and nothing contained herein should be interpreted as a recommendation regarding any
investment or investment strategy. Before making any decision to invest, first read the relevant
disclosures and important information provided to you.
Investments are NOT FDIC INSURED • MAY LOSE VALUE • NO BANK GUARANTEE