Investment Perspective

Getting Started: Establishing a Financial Safety Net

September 2012

One of my favorite things about my job is getting to know clients, learning about their financial goals and plans for the future. At Salem Five we focus on long-term planning. While we help clients plan for specific life events, like buying a home or having a child, we also encourage families to establish a financial safety net. In times of crisis, no one wants to worry about money.

As a baseline, I suggest that you have three to six months' worth of living expenses saved. The actual amount, however, should be based on your particular circumstances. Do you have a mortgage? Do you have short-term and long-term disability protection? Are you helping your child with tuition? Also consider your job security, health, and income. A financial advisor can help you work through these numbers and set a reasonable goal for savings.

Building your cash reserve

If you haven't established a cash reserve, or if the one you have is inadequate, you can take several steps to eliminate the shortfall:

  • Save aggressively: If available, use payroll deduction at work or budget your savings as part of regular household expenses.
  • Reduce your discretionary spending (eating out, movies, lottery tickets) and immediately add this to your savings.
  • Use current or liquid assets (those that are cash or are convertible to cash within a year, such as a short-term certificate of deposit). This tactic should be specifically geared toward each individual, so be sure to consult with an advisor first.
  • Consider using earnings from other investments (e.g. stocks, bonds, or mutual funds).

A final note: Your credit line can be a secondary source of funds in a time of crisis. Borrowed money, of course, has to be paid back (often at high interest rates). As a result, don’t consider lenders as a primary source for your cash reserve.

You'll want to make sure that your cash reserve is readily available when you need it. However, your typical savings account isn't your only option. There are several excellent alternatives, each with its own advantages. For example, money market accounts and short-term CDs usually offer higher interest rates than savings accounts, with little (if any) increased risk. An advisor can help you gauge which is most appropriate for your needs.

Keep in mind that common fixed-term investments, like CDs, impose a significant penalty for early withdrawals. So, if you're going to use fixed-term investments as part of your cash reserve, you'll want to stagger their maturity dates over a short period of time. We recommend two to five months. This will ensure the availability of funds, without penalty, to meet sudden financial needs.

Lastly, be sure to review your reserve periodically as your personal and financial circumstances change - a new child comes along, an aging parent becomes more dependent, or a larger home brings increased expenses.

Sean Tesoro, President
Salem Five Investment Services