April showers…!
- Apr 2
- 3 min read
By Michael Fogarty, CFP®
The cool rains of April remind us that one of the first steps of financial planning is to establish an appropriate rainy day fund. The purpose, size, and allocation of this type of reserve is unique to each household and these can change over time.
The following is a five-step process for establishing and reviewing your cash reserve
Determine your known upcoming needs that will require cash. If you will be buying a car in the coming year and plan to pay in cash, then you should consider setting cash aside, rather than drawing from your long-term investments. Write down your upcoming needs which may include a major purchase, a down payment, planned repairs or renovations, tuition payments or vacations, among the many possibilities.
Assess your needs for an emergency reserve to handle unknown needs. Some occupations have a higher risk of unemployment or underemployment, increasing the importance of preparing to replace your earnings for several months. Also, your insurance deductible may require your to cover a portion of your covered losses in the event of illness or a property loss. You will also need to gauge the likelihood of an unexpected cash need as you calculate your cash needs. Remember that setting aside too much cash might limit your lifestyle or impair your ability to save in long-term investment strategies and accounts.
Specify your cash reserve needs. Total your known cash needs and the amount you need for potential unplanned expenses. While many advisors offer a rule of thumb recommendation of 3 to 6 months of living expenses, this number may not be right for your specific needs. It offers a good starting place, but we recommend that you carefully consider what the right amount will be for you.
Choose appropriate cash accounts for your reserves. Reserves are best managed separately from a person’s daily spending account. The key considerations in allocating cash to accounts are:
degree of safety,
liquidity, and
yield.
Checking accounts typically offer FDIC protection and daily liquidity, but the yield might be lower than you might obtain elsewhere. Money market mutual funds might offer very competitive yields, but they might lack FDIC insurance. CDs can offer safety and yield, but their liquidity features might not provide the easy access you could need. Often, the best approach might include a blended allocation. For example, a couple might hold $1,000 in their home safe, $10,000 in a checking account with a local bank, $25,000 in a CD for a home renovation project in 3 months, and the balance of their cash reserves in a high yield money market fund. Also, consider whether municipal money markets with tax-free income are appropriate given market conditions and your specific marginal tax bracket.
Specify a date to review your cash needs and allocation. One thing is certain; your needs will change. Be sure to review your cash needs at least one to two times per year. Check to see if your banks have changed their interest rates and consider whether new opportunities can be found to increase your yield on idle cash.
Reviewing your cash accounts might not be as exciting as other aspects of planning for your future, but it is a very important part of a carefully constructed financial plan. Be certain that your assets are properly positioned to support your financial needs. Talk with your financial advisor or reach out to The Foundry Financial Group if you want to see how we can help.
