A couple of weeks ago, we had a fine discussion about how much we should save for retirement. But how much should we have saved for today? How much should we have in cash reserves?
As I write my own book, I'm reading (and re-reading) dozens of other money manuals. While perusing Bert Whitehead's, I came across his table of “minimum base liquidity.” (Whitehead is a highly-educated financial advisor. He uses terms like “minimum base liquidity” instead of “cash on hand.”)
Whitehead writes that people often make a commitment to save 10% of their income, but the next question they ask if where to invest savings.
The first goal is to have adequate cash reserves.
Many financial pundits in the media say everyone should have cash reserves equal to 3 to 6 months of income. For most middle-income people, that is simply a pipe dream…With our clients, I use a different and more realistic approach.
How much money should I save: Answering the big question
To Whitehead, adequate cash reserves differ depending on your circumstances. His “different and more realistic approach” uses a tiered system:
- If you are an employee with a regular income, you should have 10% of your annual income in a high interest savings account.
- In case of self-employed workers or if your income fluctuates (through commissions, for example), you should have 20% of your annual income in savings.
- Retirees should have 30% of your annual income in savings. (I'm assuming this means retirement income since if you're retired you don't have employment income.)
- If you're in danger of losing your job, you should have 40% of your annual income in savings.
Whitehead draws a distinction between cash reserves and emergency reserves. I'm not exactly clear on what he thinks each is for. I get the impression that the cash reserves — the “minimum base liquidity” — is merely the minimum Whitehead believes is necessary to have on hand for the purpose of cash flow. Use this for occasions when the car breaks down or the roof leaks.
As insurance against severe emergencies, Whitehead recommends maintaining “emergency liquidity” equal to twice your cash reserves. (He also recommends holding this money in retirement accounts, not savings accounts.)
Though I find certain elements of Whitehead's plan confusing, I do like his tiered approach to saving. It makes sense to me that not everyone should save the same amount. Our circumstances and needs are different. As always, do what works for you.
For more information, borrow Why Smart People Do Stupid Things With Money from your public library.