Building a Financial Safety Net

In times of crisis, you don’t want to be stranded, shaking coins out of a piggy bank. A financial safety net–often called an “emergency fund”–can ensure your protection if when these crises occur. An emergency fund is a cash reserve, which can be quickly tapped for unexpected events…you know, like a new transmission, a serious medical procedure, or even the loss of a job.

How much is enough?
We suggest that you have three to six months’ worth of living expenses in your emergency fund. 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, you could be financially blindsided by an unexpected event.

Building your cash reserve
If you haven’t established an emergency fund, or if the one you have is inadequate, don’t panic. You can take many steps to get started:

• 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)
• Use earnings from other investments (e.g., CDs, stocks, 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. This is often advised for younger clients and students. Be cautioned, however, that this money will of course have to be paid back (often at high interest rates). As a result, we do not recommend lenders as a primary source for your cash reserve.

Where to keep your cash reserve
Jonathan, over at MyMoneyBlog, posted a wonderful analysis of various high-interest, short-term accounts. We strongly suggest reviewing his findings. The key is to make sure that your cash reserve is readily available when you need it, earning the highest rate of interest in the meantime.

Review your cash reserve periodically
Your personal and financial circumstances change often–a baby is born, an aging parent becomes more dependent, or a first home brings increased expenses. Because your cash reserve is the first line of protection against financial devastation, you should review it every six months to make sure that it continues to fit your current needs.