Author: Emily Tierney CFP®
Is your savings for a new car you’ve been stashing away for? Is it for a cash reserve for emergencies? Will you use these savings for retirement income? Don’t get me wrong, having savings is fantastic but can you answer this question:
What’s the purpose of your savings?
Most people have some kind of savings. This typically refers to some amount of accumulated cash and/or cash equivalents held in a bank account. The problem I see over and over again is that often people don’t know what their savings is for. Defining what your savings are for can have a substantial impact on your current financial situation. By identifying what you intend your savings to be used for, you will have a much better understanding of your current financial situation.
The primary purpose of having savings should be to have a cash reserve to help you to cash flow unexpected expenses that were not in your budget. Having cash that is earmarked for emergencies is a fundamental part of being prepared to avoid debt. Life will throw financial surprises at you and being able to utilize cash from your emergency fund will help you to stay out of debt.
Do you have too much savings or too little?
Sometimes I see people that have emergency fund savings for three years worth of living expenses (too much) and sometimes I see people with three weeks worth of living expenses (too little). Knowing how many months worth of your monthly living expenses you have saved in cash is important. Why? So you know when you have the ability to put your cash towards other financial goals. For example, someone may have three years worth of expenses saved in cash, but have very little saved for retirement. As you age, being comfortable gets steadily more important. By knowing how much of a cash reserve to keep on hand for emergencies, you can put any money above and beyond the emergency cash reserve towards other goals.
Advisors typically recommend an emergency fund be equal to about three to six months’ worth of living expenses at a minimum, and potentially more depending on the situation. Knowing the exact amount of this emergency fund is important for knowing if you have too much or too little. If you had to utilize some of your emergency fund, your immediate financial goal is to replenish it. If you have too much, you know you can move on to your next financial goal.
What are your other financial goals?
Keeping an emergency cash reserve and actively utilizing a monthly budget is the key to being able to work towards your financial goals. Once you are committed to a budget and the cash reserve is in place, you want to keep it in place. If you have to dip in to your emergency fund, your priority should be to restore the emergency fund to its intended value. If you are trying to save and pay cash for a new car, for example, you want to first have the emergency cash reserve fully funded, then you can start saving towards the new car. Once the car fund is established or the car is purchased, start focusing on your next financial goal.
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