Everyone faces unplanned financial expenditures at some point in their lives, such as a major car or home repair or unexpected medical expenses. You can be prepared for these and other types of emergencies by having a cash reserve. The rule of thumb is to keep on hand enough savings to cover three to six months of living expenses. This type of contingency plan can be extremely helpful in a variety of situations.
One example is during the waiting period for a disability policy. If you have a long-term disability policy in place, you may have to wait 90 days or longer after you become disabled before you will begin to receive payments.
This type of reserve does not necessarily need to be a savings account. If you are comfortable managing debt and have a home equity line of credit (HELOC) available to you, this can be a backup for unexpected cash flows. The idea is to have something that is liquid so that you are able to retrieve it quickly in the event of an emergency.
How much do you need? Well, this is very much dependent on your personal situation. Reviewing your particular cash flows, you may need more or less than the three-to-six month rule of thumb. Below are just a couple of items to take into consideration when you are starting to think about a cash reserve:
- Do you have a short or long-term disability policy in place? If so, find out about your policy’s elimination period (time you have to wait to start receiving benefits) and try to plan accordingly.
- Are you self-employed or does your income vary significantly month to month? If so, you may need to have more in cash reserves.
- Do you have other extraordinary expenses such as tuition or the support of a family member that you are responsible for? Setting aside extra to cover these immediate expenses can provide peace of mind.
We have discussions about cash reserves with our clients, including the importance of major reserve funds accessible when they retire to cover large one-time expenses, whether good or bad, expected or unexpected. There will always be something outside your day-to-day budget for you to consider. In the end, think about how stress-free you will feel when you know that you are ready for any rainy (or sunny) day that may come your way.
Associate Financial Planner