FAQ: How much cash is enough for my emergency reserve?
When it comes to your emergency reserve, rules of thumb abound.
“You need 6 months of living expenses in cash!”
“Always keep enough cash to cover your basic expenses for one year!”
“You must have at least $10,000!”
“Subtract your age from your IQ and multiply by $500!”
The truth is, rules of thumb may be good advice for the population as a whole (okay, maybe not the last one), but can be terrible for any specific individual.
An emergency reserve is the safe, liquid, accessible cash you keep in a checking, savings, or money market account that you can access when unforeseen expenses occur, or you experience a job loss. Most financial advisors will recommend 6 -12 months of living expenses in this account, however, that may not be appropriate for you.
We believe there is a balance between sleeping well and eating well. With a little extra cash tucked under the mattress, you may sleep very well at night, which is very important. However, too much extra cash will sit in savings earning almost nothing while inflation erodes its value over time and prevents you from a better lifestyle….eating well.
As an example, you may feel very comfortable with $100,000 in your savings account in case an emergency arises, allowing you to sleep comfortably at night, but that $100,000 earning less than 1% in today’s environment means you are missing out on investing some of those funds and earning much higher returns over time. This cost is likely to be to the tune of tens of thousands of dollars over five or more years. The loss of this return can certainly hamper your lifestyle and spending.
The point is, like most things in life, it’s important to find balance. Figure out what the right balance of sleeping well and eating well is for you. Start by thinking about 6-12 months of living expenses and decide if that is too much for your personality (my income is safe, and I would rather my money work harder for me) or makes you very uncomfortable (a good night’s sleep is worth several thousand dollars a year to me). Once you figure out what that number is for you, invest the rest with the confidence that you have some cash to help through the rough patches!