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Money doesn't buy happiness, but having cash reserves might.
Experiencing life satisfaction requires a certain peace of mind. Knowing you can cover your bills and have money for emergencies can provide satisfaction that you cannot achieve any other way.
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What Are Cash Reserves, and How Do You Build Them?
Cash reserves are cash you have on hand for immediate use, whether for emergencies or other short-term needs.
Having cash on hand allows you to avoid credit card debt or other personal loans, hurting your credit score and incurring debt you cannot afford. Consumers should have three to six months of expenses in a cash reserve account.
Otherwise known as emergency funding, the cash in your bank account or other short-term investments should provide cash flow if your income suddenly stops due to job loss, illness, or any other emergency.
Cash Reserve Account vs. Savings Account vs. Investments
There isn't a right or wrong place to store your cash funds. The bottom line is that you can access the cash account anytime without excessive delays.
Any accounts considered cash equivalents can be called cash reserves. The key is to know when and how you can withdraw money.
However, some consider cash reserves only the cash portion of brokerage accounts or uninvested money. Others believe any idle cash is a cash reserve fund.
What Are Examples of Cash Reserves?
Some common examples of cash reserves include:
- Savings accounts
- Treasury bills
- Money market funds
- Money market account
- Mutual funds
- Trust funds
- Cash value of an insurance policy
- Vested funds in retirement accounts
Determine the requirements of any cash reserves you hold, including holding periods or total expenses for withdrawing the funds, to ensure you know the true value of your liquid assets.
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How Cash Reserves Work
Every consumer has a different way of managing their cash reserves.
Some have separate accounts that total at least three to six months of expenses. They only touch the account if they have a true emergency and have a valid reason for using the funds.
The more conservative you are with your cash reserve accounts, the more likely you'll have the extra cash needed during an emergency.
For example, stock investment opportunities are riskier than keeping funds in an interest-bearing bank account.
The Importance of Cash Reserves
Cash reserves help you during a time of need.
Whether you lost your job, couldn't work due to illness, or had another type of emergency, having cash readily available ensures you can cover the emergency without causing financial strain.
Having a cash reserve fund provides peace of mind not only during an emergency but all the time. You can rest assured that if unexpected costs occur, you have the money set aside to handle the costs and won't incur more debt.
How Much Cash Reserve Should You Keep?
Everyone has different requirements for cash reserves; however, holding three to six months of expenses generally ensures you can cover a standard emergency.
There isn't a rule stating you cannot save more money, though. If you worry that you won't be able to work for an extended period and are the only income earner in the household, consider a larger cash reserve fund.
The key is to save enough to cover the worst-case scenario while still investing money for the future in taxable and tax-advantaged investment opportunities.
Benefits of Cash Reserves
Adding the need to set aside cash monthly can feel like another burden to your monthly budget, but here are some of the top benefits of a well-managed cash reserve account.
Knowing you can cover most emergency funding needs with cash reserves provides incredible peace of mind.
Job loss or major illnesses are just two common examples of emergencies. Any small or large unexpected costs you must cover can throw you for a loop if you don't maintain cash reserves.
Flexibility and Opportunity
Knowing you can save money to handle unexpected expenses provides flexibility and opportunity in your everyday budget.
When you aren't sure if you have enough money to cover anything unexpected, spending money on anything except fixed expenses can be more challenging.
Reduced Stress and Anxiety
Knowing you meet mortgage reserve requirements or have enough money to cover your fixed bills allows more peace of mind.
You know you have enough money in your bank accounts even if your income stops temporarily or you have an emergency without the risk of losing your house or other assets.
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Enhanced Financial Stability
Each time you deposit money in a reserve account, you enhance your financial stability because you aren't relying on your monthly income to cover other costs.
For example, you increase your financial stability if you need money for major car repairs and don't have to use money from your regular monthly income.
Avoiding Debt Dependency
Not incurring more debt is good for your financial situation in many ways.
Don't increase your monthly expenses with loan or credit card payments, and don't damage your credit score by incurring more debt or not paying your debt on time.
Relationship Between Cash Reserves and Happiness/Life Satisfaction
There is a direct correlation between financial security and increased happiness, as shown in the Northwestern Mutual Planning and Progress Study.
The study shows that individuals who work with a financial planner or consider themselves financially disciplined have higher happiness levels and get better sleep.
Working with a financial advisor and/or being financially disciplined ensures you have enough money in financial institutions to cover financial emergencies, eliminating stress.
How To Manage Cash Reserves
Here are some ways to build and manage your liquid assets if you still need cash reserves.
- Set Clear Savings Goals: You must set a goal to have a large enough savings account or other cash reserves. Evaluate your budget to determine how much money you can save monthly. Make the amount a 'fixed expense, like any of your regular expenses, such as your mortgage or car payment
- Create a Separate Reserve Account: To avoid spending your cash reserve amount, open a separate bank account, such as a savings or money market account. This eliminates the risk of spending money you have set aside for mortgage reserves or to cover other bills
- Build Reserves Gradually: Don't expect to save enough money overnight. It takes time to build a reserve account. The key is to start today, no matter how much you can save, and continually build upon it to ensure you have enough money saved for unexpected occurrences
- Regularly Review and Adjust: It's essential to review your budget often, including your cash reserve account. Assess how much money you've saved, what you can cover, and if you should increase or decrease the amount you contribute to your accounts. To help, you can create a personal cash flow statement to help in reviews
- Utilize Windfalls Wisely: If you're lucky enough to have windfalls, such as a tax refund or work bonus, consider depositing them in bank accounts or investments you keep for cash reserves. This ensures you have the money available when needed and decreases the amount you must contribute monthly
Impact of Having Insufficient Cash Reserves
Not having enough cash funds can be detrimental to your finances.
When a short-term expense pops up that you didn't plan for, it can ruin your monthly budget or put you at risk of incurring excessive debt.
Having funds with easy access to cash reserves ensures you don't risk your financial stability.
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Can Cash Reserves Bring Happiness Beyond Financial Security?
Financial security creates a feeling of stability and happiness, making having cash reserves and happiness directly related.
When you don't have to worry about money or how you'll handle emergencies, including those from natural disasters or other factors you cannot prevent, it's much easier to live a happy and carefree life.
Is 401k Considered Cash Reserves?
Since not all 401k funds are fully vested, only the portion you can take with you is considered part of your cash reserves.
For example, if your company requires a five-year vesting schedule, making a percentage of your funds fully vested each year, only the portion you can take with you if you left the company today count toward your reserves.
Should I Prioritize Cash Reserves Over Other Financial Goals?
It's a fine line between prioritizing cash reserves and focusing on other financial goals, such as retirement.
While you shouldn't ignore your emergency funding needs, at a minimum, you should contribute as much as your employer will match to get the free funds for retirement.
As long as you have enough money to contribute to both, find the best balance to reach both goals.
What Steps Can I Take To Maintain My Cash Reserves During Life Transitions?
Always revisit your budget during life transitions, either for better or worse. For example, if you must use funds from your cash reserves, redo your budget to replenish the funds.
But if you get a raise, promotion, or start a higher-paying job, consider increasing the amount allocated to your reserves to increase your safety net.
How Can I Build Cash Reserves When My Budget Is Tight?
There are always areas you can cut back, whether spending fewer dollars on groceries, cutting out an expensive habit, or reducing a bill by shopping around for cheaper service.
Any money you can cut out of your spending, immediately allocate to your reserves to ensure you have enough saved.
What if I Encounter a Major Financial Setback and Have To Use My Cash Reserves?
Your reserves are there to use them in emergencies. Congratulate yourself for not getting into debt over the issue, and when you can, revisit your budget to determine how to replenish your reserves in a timely fashion.
Money itself doesn't buy happiness, but financial security does. Cash reserves work to help you achieve peace of mind, which often equals happiness.
Knowing the money you earn in your pay periods is put to proper use, including saving for emergencies, can create a level of satisfaction you cannot achieve any other way.