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 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.