Savings or Spending?

More often than I would care to admit, I hear people brag about how much they have saved. Often I will hear people say that they saved $50 on their groceries or they saved fifty percent on some purchase. Some people may even talk about saving for a vacation or some luxury item. I will suggest that such saving may not be truly saving at all, but rather spending in different areas. This is not to say that I am not guilty myself of saying I saved money when I felt as if I got a good deal or that I never put aside money for a large purchase.

I would argue that such savings is not really savings, though I may be able to purchase nicer stuff or nicer experiences. All of the above really translate into spending. At the end of the month if you do not have any extra to show for the money you saved while shopping, it really isn’t savings now is it? At least it is not the savings that will matter on a rainy day when you find that you need the money because of an accident or you were laid off of work, etc.

What then would I truly consider to be savings? Money that is not spent for over a year and is not designated for a specific purchase I would qualify as savings. Some of these savings may be invested, while others may be held in cash.

Spending less on items may lead to savings, but only if one has the discipline to actually put aside the amount spent rather than purchase another desired item or experience. It is an important mindset to maintain if one wants to build wealth.

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An Introduction to Cash: Part 4 of 4

What Cash Should I Accumulate Outside an Emergency Fund?

There are two primary areas where I find it is useful to accumulate cash outside of an emergency fund: large purchases/expenses and investment related savings. As it relates to investment related savings, the purpose of holding cash is not to generate return. The purpose is to mitigate some of the risk associated with the liquidity and marketability of the investments.


Large Purchases

Let us assume that you now have your emergency reserve built up and you discover your dream house, dream car, a great deal on a vacation, etc. Your dream house, car, or vacations are not emergencies. Do not tap your emergency fund for these. Now if your car breaks down, it may make sense to tap into your emergency fund for its repair. Or if your mechanic basically tells you that you are going to spend more repairing the car than it is worth, it may behoove you to spend 1-2 months’ worth of expenses on a second hand car and work on building up a car fund for a replacement when the time comes.

If you plan on making large purchases in a certain time frame AND have paid off high interest debts, it is probably a good idea to begin saving  for these purchases once you have 1-3 months of cash reserve saved. You remember that extra 20%? Part of that could be used in these areas.


Rental Property

I am going to make the bold assumption that you have a rental unit that is renting with positive cash flow. What I am about to suggest will potentially reduce your return on investment. I often recommend to my clients with rental property to consider maintaining at least 3-6 months’ worth of expenses for their rental property held in reserve in addition to a maintenance expenses account. It would not be uncommon for these together to equal 6-12 months’ worth of expenses.


This buffer helps address issues relating to vacancy rates, maintenance issues, and shifts in the market. On a side note, if one disciplines oneself to have a cash reserve for each of your investment properties, you will probably be less likely to over-leverage yourself than those who do not.


Closely Held Business

Once again, what I am about to suggest will most likely reduce the on your return on investment as it relates to your business. If possible AND if you will not fall under the trap of being taxed on accumulated earnings (talk with your tax preparer/accountant regarding this), consider maintaining anywhere between 6-12 months’ worth of business expenses in reserve. If you are a startup, consider doubling this amount. Many businesses fail due to a lack of capital. Having capital in reserve gives you increased opportunity to weather storms and the ability to adapt/expand to the marketplace.


Cash Inside of My Retirement Account?

I do not tend to advocate cash or cash equivalents inside of retirement accounts to many people who are not retired (Yes, if you have inherited an IRA this could be a wonderful example of an exception). Cash/cash equivalents as an idea for long term savings seems to be an extremely poor idea. That being said, there is a time for cash in long term savings accounts: when you are close to the age or are actually required to take required minimum distributions (RMDs).  It is never pleasant to be required to sell at a loss. For those who are required to take distributions when the market is down or face a 50% penalty on what they would have taken out, it is extremely unpleasant to say the least. Having cash inside of your portfolio can help deal with this risk in that when the markets are down, you would then be able to take the cash inside of your portfolio out so as not to suffer the insult to injury for RMDs in a down market. I personally would consider it reasonable to have one year’s worth of RMDs in your retirement portfolio with an additional two to four times your RMD in short term investments. This should be enough to weather most markets and still should provide the rest of your portfolio the opportunity to combat inflation.


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An Introduction to Cash Part 3 of 4

I now have six weeks’ worth of expenses saved.  What should I do now?

Assuming that you have a traditional steady paying job, this is a fantastic time to consider setting up a filter account.  If you have highly variable income, you may want to consider waiting until you have as much as three months’ worth of expenses set up before setting up your filter account. Two months without income could lead to a world of bounced checks otherwise. The advantage of this is that you begin to capture any bonuses/raises/promotions in savings rather than see them vanish in spending.

I have set up the filter account. Now what?

By this time, you should have paid off high interest debts. Most likely, you should have life insurance and either long term disability or long term care insurance in place. You are making sure that you are taking advantage of any free money that is available from your employer. Only now, would I say that it is probably time to begin thinking about outside investments. At this point 40% of your excess should be going to continue to build your cash reserve and 40% should be going to investments.

I now have 3 months’ worth of expenses. Now what?

First of all, congratulations, you have achieved an important step as it relates to financial freedom. You now truly have a buffer in place in case you lose your job. Chances are that between unemployment benefits, cutting expenses, and your savings you may not have to go into debt. At this point, you can also investigate increasing elimination periods for insurance policies such as disability and long term care which may decrease your insurance premiums. Keep up your savings. You are on your way.


I now have 6 months’ worth of expenses. Now what?

At this point you truly have a substantial buffer and if you have a steady income may now consider that you have an adequate cash reserve. Depending on your age and the variability of your income, you may want to consider either investing 80% of the money (if you are under 50 and have a steady job) or invest 60% and have 20% going to increase short term investments (if you are over 50 and/or have a highly variable income).


What About the Other 20%?

Yes, it is true. I keep on mentioning either 80% or 40% to here and 40% to there (which adds up to 80%) which leaves 20% leftover. The other 20% is yours to do with as you will. Feel free to spend it, give it to charity, etc. In fact, if you are not suffering from high interest debt, I will be somewhat upset if all you do is save it for emergency reserve. This money should be a treat to you.

An Introduction to Cash: Part 2 of 4

How Should I Build Up My Cash Reserve?

If you are like the majority of Americans, chances are you have too much stuff and probably way too much stuff. Many experts agree that if you have not touched something in a year, that there is a good chance that it is taking up space. Consider selling it. If you are like the one in ten Americans who have a storage locker, this should apply doubly. Not only do you most likely have stuff that you are not touching, you are paying for the privilege of not touching it. In other words, it is most likely time to liquidate some of your personal property. Note that this does not necessarily apply to items that are being held for investment purposes.

Depending on how much you have to sell, this could easily translate from several hundred to several thousand dollars that you now have to put down for your cash reserve. If you have gotten out of a storage locker in the process, this could reduce the amount that you need to save for your cash reserve as well. Talk about win-win.

Assuming that you have established a budget, you will have fixed expenses and discretionary expenses. For those who do not have any cash reserve and no debt, I recommend that you save 80% on any excess funds above fixed expenses to go into the cash reserve until they have at least one month’s worth of expenses saved. For those with high interest debt, I recommend that 40% be used to pay off the debt and the other 40% be used to build up an emergency reserve until you have months’ worth of expenses.


I have one month’s worth of expenses saved and I no longer have to live paycheck to paycheck. What should I do now?

If you have high interest debt, chances are that this should be a substantial focus on your excess money.  The major exception to this is if you have free money available to you either in the form of a discount or matches to retirement plans made by your employer. I have a very hard time arguing with free money. If you have an opportunity for free money, I suggest you take it.

Otherwise, high interest debt repayment should be your focus. At least 80% of your excess funds should be going to accelerate debt repayment. According to a recent Bankrate survey, the average credit card rate is currently is 13.71% for fixed and 14.48% for variable. (As a side note, if you run across an investment advisor who guarantees returns greater than this that is not somehow in effect subsidized by a workplace plan, be extremely skeptical, and let me know who it is).  Pay off your high interests debts.

An Introduction to Cash: Part 1 of 4

Perhaps you have heard the saying cash is king. There is a degree of truth to this statement.  Just keep in mind that if cash is king, that inflation (if not held in check) is the ever-lurking enemy that can quickly take over the kingdom.

For the sake of argument, I am going to assume that inflation is around 4% or less. If inflation is in the double digits or higher, then it very well could be this whole article should be disregarded.


What do I mean by Cash/Cash Equivalents?

Cash equivalents are items that can be liquidated within a 3 month period of time with no risk as to its value. These can include money in a checking or savings account, money market accounts, Treasury bills (T-bills), and CDs with a maturity of 3 months or less.


How Much Cash Should I Have?

The amount of cash that you should have varies on a number of factors. Factors include your expenses, how soon you are to retirement, the steadiness of your job, the nature of your investments, and the amount of large purchases you plan to make.


The Standard Answer (For Those with Steady Incomes)

Financial planners recommend that people maintain 3-6 months’ worth of expenses as an emergency reserve. When expenses are listed, this does not include taxes or savings. It does include everything else.


If something goes wrong, then you would have some time to hopefully find a new source of income. Is this guide of savings bulletproof? By no means, but it is a reasonable place to start. I find that though this can be a good recommendation for those with steady incomes, this may not be adequate for those who experience highly fluctuating/variable incomes throughout the year.


For Those with Highly Variable Incomes

Now, for my clients that have highly variable incomes, I have two different avenues to consider:

1.)    Keep your expenses below your lowest paid quarter. Then follow the standard recommendation of having 3-6 months’ worth of expenses as an emergency reserve.

2.)    Feel free to have expenses that are below your average monthly income for the year. Have 6 months’ worth of cash/cash equivalents in emergency reserve and an additional 6 months of expenses in short term investments.


It is acknowledged that there are good months and bad months and good years and bad years. Having the extra reserve helps mitigate some of the pain you may otherwise experience and may make things feel steadier rather than feast or famine. In a later post I will talk about having a filter account and how to make this work.


For Those Who are Soon to Retire/Retirees

I would strongly recommend those who are in retirement or those who are nearing retirement to consider having at least 6 months of worth of expenses in cash or near cash equivalents in their savings. In addition, I would recommend retirees to have 6-54 months’ worth of short term investments. On the other hand, I would question the wisdom of having much more than five years’ worth of expenses in cash or cash equivalents.


You are placing yourself and your livelihood to the vicissitudes of the market and the economy. Having enough money in place to weather downturns in the market which can last greater than a year is prudent. On the other hand if you have over five years’ worth of expenses in cash or cash equivalents, there is a strong chance that inflation is eating at your purchasing power.