Cash Reserves and Savings

Is it time to revisit your relationship with cash?

For many the sight of cash either physically in front of them (or in a wallet) or in a bank account tends to lead to the conclusion that it can be spent.   However, if you are like most Americans or even like most people in a first world Western country, the reality is you cannot and should not spend that cash!

Categories save the day!

Having a budget for your monthly income definitely helps the mind to ascertain that no, all the cash cannot be spent.  You can very clearly see that some of it is being siphoned off into various categories (rent! mortgage! food! utilities!).  Once the mind identifies those categories as important (rent! mortgage! food! utilities!) for most of us, we know not to spend those funds.

Doing the same with savings is also extremely important.  I tackle this two ways.  One I have several online savings accounts that I am able to name (for example, Long-Term Emergency Fund, Home Maintenance Fund or New Car or Vacation!).  Once named, these accounts have a purpose and you will (or should) think twice before touching them for anything other than a true emergency.  

The other way that I tackle this relates to my bricks and mortar savings account that is connected to my checking or current account.  As tempting as it is to quickly and easily transfer money from savings to checking, I don't by naming my funds.  I use a spreadsheet to do this and take the total amount of savings and then divvy it up (on the spreadsheet) into sub-accounts.  (Using an online bank to have many savings accounts - some let you have up to 20 I believe - is easier but the spreadsheet method works for me just as well.)

The spreadsheet sub-account method is very organized and very clear as to what money is for what purpose.  As an example, the amount of my annual home insurance is clearly labeled in once cell and then next to it is the current total I have saved.  I also have a third column where I calculate how much is left to save until I hit the goal.  It would look something like this:

Home Insurance ($1,200 p.a.)     $1,000     $200*Thus if according to my monthly budget, I am putting away $100/month, I have saved for 10 months

Cash Reserves
Now that is all well and good for things that you have a near-term (i.e. one year) plan for spending.  But it does get a little more tricky for things that you need to build up - specifically emergency funds.

I'll add the note that some people don't like the idea of emergency funds.  Some people call them (or have an additional account or sub-account for) opportunity funds.  Personally I like to state what they are intended to be used for and an opportunity fund (new job overseas!) is not the same thing to me as an emergency fund (job loss *sigh*).  I would use an opportunity fund for an emergency but not vice versa.

Ultimately, they do fall into the bucket of cash reserves and these take a lot of time to build up and are hopefully not drained too often.

For many of us, myself included, building up cash reserves can seem daunting.  At first I only focused on a few months and then one year and so on.  Over time, I read more (real news, personal finance blogs and books, personal stories) and it cemented in my mind the importance of having a very solid and large cushion - not just for today but also in retirement.  

I also listened a lot.  When someone I knew or was speaking to talked about something that seemed important financially (especially when it was bad or uncomfortable news), a little Pru would fling open a door in my brain and rush out, grab the information and then hurtle back into that room and shut the door.  I'd retain that knowledge and then I'd be working on a budget or reviewing my expenses and suddenly the information would reappear (hey remember when John said blah blah blah) and I'd make a small adjustment.  

I also talked about what I read especially if it was a particularly sad article (we humans tend to focus on sad stories like loss) and it would also cement the information in my mind.  (did you read about that investment banker who was laid off and is now working as a waiter at the restaurant he used to lunch at?  he can't pay his mortgage, needs to pull his kids out of school and move somewhere else but he isn't sure if he can get another job somewhere else.)

Finally, I started focusing much longer term.  Now while I consider myself to be conservative (build that cushion baby!), I am more of a risk taker when it comes to investments.  Lots of stocks because I know that I need growth for retirement purposes.  I realized in retirement I also have to have a good sized cash reserve cushion - possibly even more so than today.  I won't be working so I can't fall back on a salary.  And since most of my assets (ahem my new income) will be invested in the market, I will need to ride the waves.  I can't simply shift everything from stocks to bonds because if I live a long time, I still need the stocks to grow enough to more than cover the effects of inflation.

But that cash reserve cushion needs to help support me during a downturn in the market because the very last thing you want to do is pull money out of the market when prices/values are low.  Best to keep it in the market so it has time to recover.  As of today, I have settled on 3 years.  (Note this could change as I get close to actual retirement.)  In my opinion, in retirement it is always prudent to have at least one year's worth of expenses in cash and the other two years will give the market time to recover but also time for you to adjust your spending/expenses if it looks like the downturn will last a long time.  That's plenty of time to move to different housing, take in roommates, adjust entertainment activities etc.

I am nowhere near these three years but it is something to work towards.  Also, I wouldn't automatically group these three years with my emergency fund.  Because even in retirement you could have a major emergency and you don't want to be pulling from your basic annual expense fund to cover an emergency and then you have a huge expense.  (Ultimately, it will depend on how I end up calculating my three years.  I may include an emergency amount in each year.)

What is the point of all this rambling?  
1) Cash is so very important and needs to be viewed through the lens of not spending it until you are sure that there isn't a purpose for it.
2) Figure out what works best for you to get to this point (name accounts, create virtual sub-accounts, etc.).
3) Move your thinking and planning beyond just the next year's expenses, which you can aim to save for on a monthly basis, toward much longer-term like retirement.
4) And as always, review, assess, evaluate, adjust as need be.
Build that cash reserve cushion baby!
Pru