Cash Reserves in a Financial Plan
EntryFamilies and the Next Generation8 sections9 cited sources
Contents
Brent O’Mara has sat with clients through transitions, retirements and business handoffs among them as well as deaths in the family, and the plainest preparation for the harder ones is a sum of money kept apart from everything else. The materials are ordinary. The Consumer Financial Protection Bureau lists the places such money is kept: a dedicated account at a bank or a credit union, which it calls generally among the safest places to put money; a prepaid card loaded with a fixed amount and not connected to a bank; or cash at home or with a trusted relative, with the caveat that cash can be stolen, lost or destroyed.1 Investor.gov adds savings accounts, checking accounts and certificates of deposit, insured by the Federal Deposit Insurance Corporation or the National Credit Union Administration, and names the trade: security and availability in exchange for a low interest rate that may not keep pace with inflation.3 University of Minnesota Extension, writing for families preparing for a disaster, prefers an account at a financial institution to a jar in the house, since the jar can be destroyed in the very event the money was saved for.7
What the fund is
The bureau defines an emergency fund as a cash reserve set aside specifically for unplanned expenses or financial emergencies, car repairs, home repairs, medical bills or a loss of income, as distinct from routine monthly spending. Its reason for the fund is drawn from research: people who struggle to recover from a financial shock have less savings to protect them from the next one, tend to rely on credit cards or loans that turn into debt, and may raid other savings, including retirement accounts, to cover the gap.1 The Minnesota program splits the fund in two, set aside savings for periodic expenses that do not come every month and emergency income savings to cover essentials after a job loss or a cut in pay, the second typically equal to three to six months of income.7
Two kinds of savings inside one fund
| Set aside savings | Emergency income savings | |
|---|---|---|
| What it pays for | Periodic, nonmonthly expenses: a broken appliance, a tire, travel to a sick relative | Essentials after a job loss or a cut in income: rent or mortgage, utilities, the car payment and insurance |
| How much | Built into the monthly spending plan | Typically three to six months of income |
| What it prevents | Small shocks turning into credit card debt | Eviction, foreclosure or repossession while income recovers |
How much, by the conventions
Kiplinger states the common rule, three to six months of basic living expenses, and immediately qualifies it: a single person may be comfortable with less than six months, a household with a spouse, children and a mortgage, or with income that would be hard to replace, likely needs six months or more.8 Investor.gov reports that some savers hold up to six months of income so that it is certain to be there.3 The CFP Board’s consumer site gives the same three to six months and explains the fund’s place in a retirement plan: without a cushion of cash, a person hit by sudden unemployment or an unexpected bill is more likely to draw on retirement savings, to the detriment of the plan.9
How much, by the critics
The convention has its skeptics. A New York Times columnist argued in 2012 that the three to six month rule is arbitrary, that few people have that kind of money anyway, and that it says nothing about where the fund should rank against paying off credit card debt, saving for retirement or saving for college. He proposed renaming it an uncertainty fund and sizing it by two questions: how much uncertainty is in the person’s life, including the risk in a career once thought safe, and what resources besides savings could be called on, a home equity line, a spouse who could work, disability insurance or a fallback trade.4 A founder writing in Inc. argued the other direction: she set aside nine months of living expenses before starting her company, recommends nine months for a single entrepreneur, a year for a married one and more with children, well above the three to six months that may suit an employee, on the ground that about half of businesses survive five years and a founder whose company fails may take longer than expected to find the next income.6
How much Americans had set aside in 2018
Who has one
The surveys are consistent and discouraging. Inc. reported a June 2018 Bankrate survey of 1,000 adults in which about 23 percent of Americans, some 55 million people, had nothing in an emergency fund; among those with one, 29 percent had at least six months of expenses, 18 percent had three to five months and 22 percent had less than three.5 The Inc. founder cites two older findings, a national survey in which about two thirds of Americans lacked $1,000 for unforeseen expenses and a study in which nearly one in four households earning $100,000 to $150,000 said they probably could not raise $2,000 within thirty days.6
How it is built
The bureau’s guide is organized by strategy and by who each suits. A savings habit, with a specific goal, a fixed contribution and a way to watch the balance grow, suits anyone with steady income. Managing cash flow, by moving bill due dates and saving in the weeks when more money is on hand, suits anyone at all. One time windfalls, a tax refund or a birthday gift, are the easiest start for people with irregular income. Automatic transfers from checking to savings, and a direct deposit split between two accounts by the employer, make the saving happen before the spending does.1 Minnesota’s version is the older phrase, pay yourself first: a set amount or percentage of each paycheck into savings, loose coins and tips into a jar that goes to the bank when full, part of every gift saved.7
Five ways the CFPB suggests building a fund
- A habitA goal, a fixed amount per day, week or payday, and a way to watch it grow, for people with steady income
- Cash flowMoving bill due dates and saving in the weeks with more money, for anyone
- One time moneyAll or part of a tax refund or a cash gift, especially for irregular earners
- Automatic transfersA recurring move from checking to savings, with balance alerts to avoid overdrafts
- Through workSplitting a direct deposit between two accounts so the saving happens first
When to use it
The bureau suggests setting personal guidelines for what counts as an emergency, since not every unexpected expense is dire, and being consistent; a medical bill that insurance did not cover qualifies even without a trip to the emergency room. Using the fund rather than a credit card or loan keeps a one time expense from growing with interest and fees, and the guide’s instruction is not to be afraid to spend it, then to build it again.1
The reserve in retirement
Near retirement the question changes. Kiplinger’s adviser suggests that people approaching retirement may want more than the standard six months, holding two or three years of expenses as a cushion, so that a weak stretch for investments does not force sales to pay living costs.8 The CFP Board frames the same idea as building savings first, paying off debt and leaving long term investments in place rather than moving them in a downturn, with the reserve as the thing that makes the patience possible.9 A household that is also supporting a parent, the situation described under the sandwich generation, often finds its reserve doing two families’ work, and a household that has just inherited a retirement account faces a separate question about how much of it to keep liquid.
Rebuilding after a shock
A second bureau page, written for National Preparedness Month during the pandemic, addresses the household whose fund has already been spent: the first step in rebuilding is to restart the fund, any amount makes a difference, it is never too late to begin, and the more that is saved the faster the recovery when the emergency ends.2 The habit itself is one of the earliest money lessons, the subject of teaching children about money.
What comes next for a reserve is that it gets spent, which is the point. The sources above agree on the sequence more than on the number: a fund is sized to the household’s uncertainty rather than to a fixed rule, kept where it is safe and reachable, used without guilt when the event arrives, and then rebuilt from the first paycheck afterward. How large it should be, and how it sits beside debt, retirement savings and the inheritance questions covered under the great wealth transfer, depends on a person’s circumstances, and the tax and planning choices around it are for qualified professionals.
See also
The Sandwich Generation
A reference entry on adults caring for parents and children at once, with the survey numbers, the sibling arithmetic and the money conversation.
Inherited Retirement Accounts
A step by step reference on the rules an heir meets after inheriting a retirement account, from the designation form to the last required withdrawal.
The Great Wealth Transfer
A reference entry on the research behind the phrase, why the numbers keep changing, where the money goes first, and what the household data can actually show.
Teaching Children About Money
A reference entry on the studies behind the advice, from three year olds saving marbles to the fifth of American teenagers who fail a basic test.
What a Will Does
The oldest estate document names heirs, an executor and a guardian, yet it governs only the property that nothing else has already claimed.