Typically, a good financial plan will help you organize your money and cash flow so that you have cash available when you need it. Here are some important considerations as you grow your savings:
Set Your Liquidity Target
Liquidity means how much cash you have on hand to pay for things. I recommend having 3 to 9 months of net income accessible to you for an emergency situation. The key to this target is evaluating how much risk there is to your income. If you have a steady paycheck in a low turnover environment and there is not much risk to your cash flow, then you can get away with less cash (probably 3 months net income). If you are in a volatile industry, or worried about cutbacks, it is a good idea to have more of a cushion (probably 9 months). This money should be for when there is a threat to your cash flow or a significant expense that you can’t pay for out of cash flow. Everyone has different circumstances, but there are things that happen, that we just can’t plan for. That is life. When life happens, you typically need some cash.
Automate
The best way to build your savings is to automate. Pick an amount that you can set aside each month and have it automatically taken out of your account. This takes the decision-making out of the process. Once it is set up, you can increase your automated savings each year or whenever you have an increase in your income or a decrease in expenses (like paying off a debt).
Savings vs. Debt
U.S. adults are carrying an average debt excluding their mortgage of $28,900[1]. Paying on debt typically is one of the most common challenges that we face as I work with people on building their cash savings. Many people feel overwhelmed by their debt payments and want to see progress on paying debt off before they save money.
While I agree that paying off debt should be the primary goal, I advise to not wait on building up savings. Life doesn’t really stop and wait, so typically there is always another major expense coming up. If you create a habit to add money periodically to savings along with paying off your debt, you often can reach your target goals sooner.
Where to Put Your Cash
I recommend keeping a comfortable amount in your bank in a savings or money market account. However, if your money is in cash earning less than 2% you are losing money to inflation each year. Because of this, I typically recommend keeping the bulk of your liquid savings in a high-yield savings account or money market. If you have excess cash, then consider bonds or a conservative portfolio of high-quality investments.
Plan Ahead
It is smart to think about how much time you need to access money for your goals. You shouldn’t feel the need to cash out of investments because of market circumstances or income needs. I recommend planning 2-3 years in advance to access income from your portfolio. This means that you should keep money in cash for financial goals within 0-2 years. If you have goals beyond 2 years out, you should feel comfortable investing the money for a higher return, but be conscious of your risk. I typically recommend at least a 5 year time horizon for money to be put into risk assets like stocks.
Anything helps
What if you feel cash poor? Start now. Set a small goal to get one month of income in savings. Once you are there, celebrate your success and set a new goal. This is where a solid financial plan starts.
[1] Northwestern Mutual’s 2019 Planning & Progress Study. https://news.northwesternmutual.com/planning-and-progress-2019