One of the traps that many people fall into when it comes to debt is not having any cash reserve or emergency fund set aside. If you have no money set aside for emergencies you’re going to be in trouble when life’s unexpected crisis happen. Your refrigerator may go out. Your car may break down unexpectedly. You may have an unexpected medical bills the insurance doesn’t cover. There hundreds of things that could possibly go wrong they could demand a large chunk of money right away. If you have no cash to pull from for these situations you will have to take out some type of loan. Obviously when you’re in a situation where you have to get a loan you’re at a disadvantage. You can’t negotiate good rates. Whenever you can’t walk away from a loan the lender as you pretty much at his/her mercy.
There are several different theories when it comes to how much reserve you should have. Many people suggested she should try to get to a point that you have six months living expenses in cash reserve. The idea is that if you lose your job this gives you a cushion of up to six months to find a new one. There is some value in that but it’s possible that that cash reserve should be separate from your emergency cash reserve. You want to make sure that you have a way to deal with things that are likely to break. It’s probably worth considering all the things that could possibly go wrong that would require the outlay of cash. Your cash reserve should be enough to cover a number of those things happening in a given month. For example you should probably know approximately how much it would cost to replace your furnace if it goes out. The furnaces and something that you can just decide not to use–you have to have it during the winter months. Your car is another thing. Your car was somehow destroyed in a way they insurance didn’t cover it do you have the necessary funds to buy another vehicle. You don’t necessarily need enough cash reserve to buy an expensive vehicle–just something to be okay to work. Major appliances are another area you should consider funding through a reserve emergency fund. If your refrigerator, washing machine, or dryer were to suddenly stop and require purchasing another one you want to make sure you’ve got enough way to cover that.
If you add up all your potential things that could break that would need to be replaced immediately trying to have cash reserve to cover all of those happening at once would be a good idea. Honestly for some people that is impractical. However setting up cash reserve to cover at least 50% of them breaking in a given month isn’t a bad idea either. Remember the more money you have set aside the more flexibility you have been making good decisions when an unexpected crisis arises. Also make sure that you don’t just take into account your appliances in major purchases. Health care is another major area where cash reserve used in emergency may come in handy. Obviously healthcare costs can vary greatly. It’s easy to rack up half $1 million in healthcare costs very quickly. You should have some time help insurance to cover most of this. However the deductible–the party responsible for–is something the insurance won’t cover so it would be wise to have cash reserve to cover the amount of the deductible if you need to pay out of your own pocket.
Now normally you want to keep your cash reserve in some type of fund where you can access it quickly. However when your cash reserve gets to a certain point you may want to consider investing at least part of it. You still want in a short-term investment that you can get to I can be in something that may take a little bit longer than coming out of an ATM area wanting you want to watch out for though is using your cash reserve as retirement investment. You don’t want to get into a situation where you’re going to have to pay large fees, penalties, or taxes in order to get at the money. This is the type of thing that’s likely to happen if you put the money into a traditional IRA. However a Roth IRA may not be a bad idea. You can take the money back out of a rock that you can originally put into it. So if you set aside $10,000 you can put into a Roth IRA and hope you never have to touch it. If you do have to take it out you can take out the entire amount you put in without any penalties. However you can’t take out any of the money that earned or any of the money it increased. This should work out perfectly if your cash reserve is enough to meet your needs because it means it will grow into tax advantaged way but still be available if you ever need to pull it back out.
Another potential benefit of having the cash reserve in a Roth IRA is what would happen if you became bankrupt. There certain types of accounts that cannot be touched during a bankruptcy. Some IRAs meet this criteria. If that’s the case then it can be a great way to protect your assets in case some huge unexpected expense forces you into bankruptcy–this would have to be an expense that was so great that you wouldn’t be able to pay it using your cash reserve. Such a situation is probably unlikely if you’re managing your money carefully. However on unexpected large lawsuit or other type of situation could push you over the edge.
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