Most financial advisors recommend saving the equivalent of 6-12 months of after-tax wages into a highly liquid vehicle, such as a savings account or money market, before putting money into other investments. Though current returns are absurdly low as of this writing, it still is important to have this cash reserve for unforeseeable events that may severely curtail your ability to earn money.
Let me give you a personal account. After years of regular, disciplined saving, we eventually accumulated over 4 years of cash-on-hand, which is to say if I couldn’t work, our family could live for four years just on that cash. This was unintentional and occurred while paying off my student loans, funding our kid’s college funds and our retirement accounts. It was all a matter of proper budgeting in a one bread-winner household, separating needs from wants and not buying unnecessary items we could ill-afford. Yes, we were frugal, but we did not lead a deprived lifestyle. I also waited for buying opportunities in other investments while maintaining the same savings discipline, but purchasing less of those other assets than we were depositing. This fortunate happenstance was (and still is) very liberating.
A cash reserve does wonders for your psyche. Negative events will inevitably occur; it’s a natural part of life. You’re just better prepared to weather the storm. No one can predict the future. Whether it’s a stock market crash, a job loss, a severe reduction or loss in your business or an unexpected illness, your cash reserve softens the blow, reduces panic and provides more time for a calmer strategic plan of future action.
This all feeds into the motto: “Hope for the best, but prepare for the worst.” As most business folks will tell you, hope is not a strategy but preparation is.
Case in point: during the early months of the Corona virus pandemic, my medical practice was severely curtailed due to state proclamations restricting our ability to do surgery. I had little to no income for three months, despite still working and taking call for the hospitals. Yet our family had enough saved for our living expenses, but more importantly, I was able to keep my employees on the payroll and working. Thus, the savings strategy had a wider positive impact extending beyond my immediate family.
My recommendation is to gradually accumulate a cash reserve well beyond the 6-12 month cushion. You’ll have money to invest when an opportunity arises. During a big market decline, you’ll find yourself more calmly prepared and strike when others sell into the panic. This changes your mindset; you are more inclined to see the positives in the midst of misfortune. You become optimistic and proactive rather than a victim of circumstance.
Ample saved cash solidifies in your mind you are anticipating the negative stuff in the future that are a natural part of existence. If anything is certain other than death and taxes, it’s uncertainty. A sizeable cash cushion tells you and your loved ones you are prepared. Much like storing nonperishable food for an unlikely (but not impossible) famine created by cataclysmic events such as natural disasters, war, epidemics or the Zombie apocalypse, a cash reserve will help you through tough times.
A nice cash reserve also allows you to live more in the present, in the here-and-now, knowing you are better prepared. You worry and dwell less about the unpredictable future. In this ironic respect, saving money can be very Zen-like, helping to create mindfulness. And this is something many of us need in this day and age.
©Randall S. Fong, M.D.
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