Establishing a Financial Safety Net
Just as the train approaches the steep hill the Helper locomotives latch on to assist the train over the grade. The Helper locomotives are a short term solution to immediate challenge the train faces. You should think of the financial safety net the same way. It is a bundle of liquid cash that helps your family get over short term challenges that come up in life.
How much is enough?
Most financial professionals suggest that you have three to six months' worth of living expenses in your cash reserve. 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, a period of crisis (e.g., unemployment, disability) could be financially devastating.
Building your cash reserve
If you haven't established a cash reserve, or if the one you have is inadequate, you can take several steps to eliminate the shortfall:
• 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, such as a short-term certificate of deposit)
• Use earnings from other investments (e.g.,stocks, bonds, or 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. Borrowed money, however, has to be paid back (often at high interest rates). As a result, you shouldn't consider lenders as a primary source for your cash reserve.
Where to keep your cash reserve
You'll want to make sure that your cash reserve is readily available when you need it. However, an FDIC-insured, low-interest savings account isn't your only option. There are several excellent alternatives, each with unique advantages. For example, money market accounts and short-term CDs typically offer higher interest rates than savings accounts, with little (if any) increased risk.
Note:Don't confuse a money market mutual fund with a money market deposit account. An investment in a money market mutual fund is not insured or guaranteed by the FDIC. Although the mutual fund seeks to preserve the value of your investment at $1 per share, it is possible to lose money by investing in the fund.
Disclaimer: This article is provided for general information and illustration purposes only. Nothing contained in the material constitutes tax advice, a recommendation for purchase or sale of any security, or investment advisory services. I encourage you to consult a financial planner, accountant, and/or legal counsel for advice specific to your situation. Reproduction of this material is prohibited without written permission from John McNamara, and all rights are reserved.