Last week I introduced our Edu-Blog topic for the next two months - preparing for what can go wrong and investing for what can go right. This week we are going to start jumping into the “what can go wrong” part of that topic. These are things like emergencies, accidents, health issues, death, and disability. So let’s jump right in and talk about strategic liquidity.
What is strategic liquidity? Well, we know liquidity is the ease with which you can access your money. Strategic liquidity is simply allocating that money in ways that help you manage emergency situations better. These are things like an emergency fund and a loss of income fund. Let’s start by talking about creating an emergency fund.
We’ve all experienced unexpected financial emergencies—a fender bender, an unexpected medical bill, a broken appliance, a loss of income, or even a damaged cell phone. Large or small, these unplanned expenses often feel like they hit at the worst times.
Setting up a dedicated saving or emergency fund is one essential way to protect yourself, and it’s one of the first steps you can take to start saving. By putting money aside—even a small amount—for these unplanned expenses, you’re able to recover quicker and get back on track toward reaching your larger savings goals.
An emergency fund is a cash reserve that’s specifically set aside for unplanned expenses or financial emergencies. Some common examples include car repairs, home repairs, medical bills, or a loss of income.
In general, emergency savings can be used for large or small unplanned bills or payments that are not part of your routine monthly expenses and spending. Without savings, a financial shock—even minor—could set you back, and if it turns into debt, it can potentially have a lasting impact.
Research suggests that individuals who struggle to recover from a financial shock have less savings to help protect against a future emergency. They may rely on credit cards or loans, which can lead to debt that’s generally harder to pay off. They may also pull from other savings, like retirement funds, to cover these costs. I generally suggest you have about one to three thousand dollars in your emergency fund.
Salary Replacement Funds
Next, if you are still working, you should think about creating a salary replacement fund if you lose your job. Ideally, this fund will be separate from your emergency fund and have the cash equivalent of three to six months worth of your salary in it. In fact, most financial experts recommend that you have somewhere between three months and six months of basic living expenses in your emergency fund.
The three-month guideline is generally recommended for those who are in salaried positions and have more secure employment. The six-month recommendation is for those who have less stable employment or earn variable incomes. If you fall into the second category, an income reduction may even be more likely than a complete job loss. A paycheck replacement fund can be used to help cover your basic living expenses during a time when your income has been reduced.
Naturally, you’ll need to rebuild your account when your income increases. The basic idea will be to build up the account during high-earning months in preparation for low-income months.
Tune in next week when we will discuss handling unexpected health issues and disabilities.
Until next time…
One last thought, I believe an educated investor is an empowered investor. If you like what you’ve read and think your friends and family can benefit as well, please share.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.
All investing involves risk including loss of principal. No strategy assures success or protects against loss. There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.
Dollar cost averaging involves continuous investment in securities regardless of fluctuation in price levels of such securities. An investor should consider their ability to continue purchasing through fluctuating price levels. Such a plan does not assure a profit and does not protect against loss in declining markets.