At some point in your financial life you have more money than you need to live on, so you invest it. But even after you have built a big nest for the money eggs, you still need a cushion, an emergency fund, or some readily available cash that’s always there when you need it. But how much do you need? Here are four ways to help you find the answer.
First things first
The first step in creating a cash cushion is to realize you really need one. Stuff happens. Things change. Big expenses pop up. Families change. Careers take twists and turns. Without a cushion, you may have to liquidate investments you intended to hold for the long term, skewing your risk level or triggering capital gains at the wrong time. But if you plan ahead, no problem. You have a cushion, a convenient and liquid safety net. Now, how much?
The magic number way
The magic number way is derived from a bit of family lore you grew up with or heard from your parents, the practical aunt or the rich uncle. It’s an absolute number, which makes it easy to spot and aim for. “A million dollars in the checking account” is one client’s definition. Another one is “always have ten thousand dollars ready.” Based on my experience $10k is a little low for the cushion, and a million is a little high. The right number is somewhere in between, chosen by you and your partner. The point is, do have the discussion and do set the money aside.
The formula way
The formula way is usually based on the time you might need the cushion to fortify your finances, say, “six months salary” or “a year of living expenses.” Just check your W-2 or 1099 to determine how much income you might need to replace, or calculate how much you actually spent in the last year. Be honest with the numbers. If you spend $15,000 a month, there’s no sense pretending $10,000 will be enough. Let your real numbers guide you. You can solve this.
The practical way
The practical way is a common sense, rational guess at how big your cushion should be. Those who can make non-emotional money decisions or who value a rational financial approach like the practical way. It’s your best guess, and you know better than anyone what the number has to be. Cross-check your best guess with the magic number and formula ways to confirm your judgment. Set the number and set it aside.
When you fall back on the cushion, what next?
Sometimes you need the cushion. You may be taking your career in a new direction. Or having a child. Or taking the trip of a lifetime. Or supplementing a loved one for a while. Don’t feel guilty for tapping into the cushion. That’s why it’s there. But if it’s more than a very temporary situation, be sure to check in with you advisor for a discussion about your financial situation and goals. Often, there is a change that should be made to your investments because of changes in your family, career, health or vision for the future. When the temporary need ends, make a plan to refill your cushion account.
Do it today
Putting a cushion in place is one of the easiest ways to prepare for an unknowable future. Using any one, or several, of the cushion calculators you can figure out how big your emergency fund should be. Then you can rest easy, feel smart and focus on what’s really important.
John Osbon – email@example.com
- This communication may include forward-looking statements. All statements other than statements of historical fact are forward-looking statements (including words such as “believe,” “estimate,” “anticipate,” “may,” “will,” “should,” and “expect”). Although we believe that the expectations reflected in such forward-looking statements are reasonable, we can give no assurance that such expectations will prove to be correct. Various factors could cause actual results or performance to differ materially from those discussed in such forward-looking statements.”
- “Historical performance is not indicative of future results. The investment return will fluctuate with market conditions.
- Past performance is not indicative of any specific investment or future results. Views regarding the economy, securities markets or other specialized areas, like all predictors of future events, cannot be guaranteed to be accurate and may result in economic loss to the investor.
- Investment strategies, philosophies, allocations and holdings are subject to change without prior notice.
- This communication is intended to provide general information only and should not be construed as an offer of specifically tailored individualized advice.
- While the Adviser believes the outside data sources cited to be credible, it has not independently verified the correctness of any of their inputs or calculations and, therefore, does not warranty the accuracy of any third-party sources or information.
- Adviser does not endorse the statements, services or performance of any third-party vendor.
- Unless stated otherwise, any mention of specific securities or investments is for hypothetical and illustrative purposes only. Adviser’s clients may or may not hold the securities discussed in their portfolios. Adviser makes no representations that any of the securities discussed have been or will be profitable.