Building a solid financial plan is relatable to building a strong house. If you create a secure foundation and structure for the house, it is likely to stand up against all of the elements over the course of the years to come. Many financial plans fail because the two key areas of the foundation which include having an appropriate cash reserve and having adequate risk management protection are not put into place before people begin investing. There are often various numbers thrown around in the media about what is an adequate cash reserve to have in your financial plan, but here are some thoughts for consideration on how much money to have in checking, savings, and other short-term investment instruments.
The first question you should be asking is whether you are employed (and where your job stability is at work) or whether you are self-employed. My opinion is that people who own a business should have about double the normal cash reserve of someone who is gainfully employed with a corporation.
The second question is do you anticipate any major life changes over the next year. This could be the birth of new child, an upcoming marriage/divorce, or potentially relocating your job to another part of the United States. These changes often create the need for more cash as your cash flow will likely be unstable.
The third question is what major changes do you see happening with your employer over the next 12 to 24 months. Do you see more layoffs coming or a department restructure? Do you see the company cutting the commission/bonus plans of the salespeople? Questions like these are important for impacting cash reserve.
Last, do you plan to retire over the next year or two which may impact how much you have to beef up your cash reserves? So, here are my thoughts on what you need in savings for emergencies or opportunities that may arise.
- Gainfully Employed By A Corporation – If you (or/and your partner/spouse) are employed by a Fortune 500 company, most of you will need about 6 months of monthly expenses squirreled away in a cash reserve account. If you work for a smaller corporation or are worried about job stability, then I would recommend 9 months to 12 months in savings. The old rule of thumb of three months is too little in my mind given the economic uncertainty we have today and how fast people change employers.
- Self-Employed – If you run a business that is less than five years old, I would suggest that you build up at least a year in cash reserves. This could be some combination between business checking cash and personal savings cash. Until your business maintains a level of consistency of monthly cash flow, you should maintain a larger bank account in case the business runs through a rough patch. For business owners, it is more important to plan out the business plan and expansion of the business as you’ll need to consider whether cash, cash flow, loans, or equity will capitalize your business as it grows.
- Retired – For folks that are entering their first year of retirement, I would recommend at least 12 to 18 months of cash. Typically, the jubilation phase of retirement (first couple of years) is where retirees overspend against a normal budget until they get into a regular groove of what they will be doing in the next phase of their lives. About 24 months into retirement, you can get a better gauge on overall expenses and then set the bar for a more normal cash reserve.
I recognize that it can be frustrating to have lots of money in cash because interest rates are non-existent on checking accounts and are less than paltry on savings and money market accounts. Even CD’s (Certificate Of Deposit) do not offer the kind of rates that they did in the 90s’ or early 2000’s. However, the idea of cash reserves within a financial plan is to have resources set aside specifically to take care of the unforeseen expenses that will arise in our financial situations. Or they can be used if there is a unique opportunity for us to take advantage of without destroying the integrity of retirement savings, college education savings, or other financial goals you may be trying to achieve. Follow these rules of thumb and you’ll build a slab of financial concrete that can weather even the worst of storms.
Go to www.oxygenfinancial.net to request a meeting with Ted or his staff at oXYGen Financial to do an analysis of your financial situation.
Written by:
Ted Jenkin, CFP®, AAMS®, AWMA®, CRPC®, CMFC®, CRPS®
Co-CEO and Founder of oXYGen Financial, Inc – The Leaders in Gen X & Y Financial Advice and Services
Ted Jenkin is one of the foremost knowledgeable professionals in giving financial advice to the X and Y Generation.
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