Life is full of unexpected surprises. Sometimes these surprises take the form of a hardship, such as losing a job or coping with an illness. Other times, we’re encountered with exciting revelations, such as a work promotion or new business opportunity. We may not have a great deal of control over the obstacles and opportunities that present themselves, but when financially prepared for these unpredictable events, we are better equipped to control the implications. A cash reserve provides this financial safety net to better prepare us for any unplanned short-term financial requirements.
What is a cash reserve?
A cash reserve refers to funds specifically earmarked for unforeseen emergencies or opportunities. Money Market, Certificates of Deposit, and Savings Accounts are examples of investment strategies that can be used as part of a cash reserve. These funds need to be liquid and invested very conservatively, to ensure they are available if and when the time arises to use them. Conversely, investments such as individual stock, stock mutual funds, or other investments that can be volatile should not be used as part of a cash reserve strategy.
Why are cash reserves so important?
You’re better prepared for unexpected costs. In a world of unexpected outcomes, financial preparation is vital. When faced with an unpredicted cost, such as a substantial medical bill, a cash reserve allows you to take care of these costs without burdening your wallet.
Your current finances remain unscathed. When there is no cash reserve in place and an unexpected cost emerges, your options are limited. You may resort to interfering with other investments or savings accounts to deal with the cost, which is only going hinder your progress towards achieving your financial goals. With a cash reserve in place, your other financial accounts are protected, and you avoid debt from taking out a loan.
Take full advantage of opportunities. New investment opportunities often require an initial cost. Cash Reserves provide you with the ability to take advantage of any opportunities that may arise without having to use consumer debt (ie. credit cards), which can carry high interest rates.
How to get started?
If you don’t currently have a cash reserve, you can begin systematically building one by adding money into a banking account or other liquid investment strategy on a monthly basis. It’s important that this account be separate from the account that bills are paid out of. Set a goal as to how much you’d like to contribute to the account each month. You can make adjustments to your monthly deposit as need be.
Another option you have is to automate it at the bank. You can have the bank regularly withdraw automatic drafts from a checking account and place the money into the cash reserve account.
Your employer might allow you the option to direct deposit funds from your compensation to additional accounts. If this is the case, it may make sense to have funds deposited to a secondary account, which could be earmarked as a cash reserve account.
How much should go into a cash reserve?
The amount of money that should be placed into a cash reserve depends on the unique needs of the company or individual. A general rule of thumb is that the amount should equate to about three to six months’ worth of expenses; including insurance, food, groceries, gas, and so forth. For example; if your monthly bills total about $3,000, you should have no less than $3,000 in the reserve, but a more ideal number would be closer to $9,000.
A cash reserve that has either an insufficient or overabundant amount of cash opens the risk for future consequences. When faced with an unexpected cost, a reserve with an inadequate amount of cash may cause you to begin interfering with other investments or incurring debt through a loan. An abundance of cash in the savings account might seem promising, but allocating an unnecessary amount of cash could forestall you from making other investments.
A financial advisor can help you determine the appropriate amount you need to have in the reserve by taking a holistic approach in assessing your personal financial situation. This process entails the analysis of your cash flow statements, earnings, and expenses. Once they’ve determined the ideal amount for the reserve, they’ll work with you in implementing an effective strategy for creating the reserve, and more importantly, educating you on the most appropriate investment and saving vehicles.
Schedule a call with an experienced financial advisor at Archstone Financial to begin implementing your cash reserve for a more secure financial future.