Have you ever wondered whether you have too much or too little in savings at the bank?
Having too little cash is a risk. Not only does it cause emotional distress, but it may put us in a position to require the use of high-interest debt to cover emergencies. Having too much cash in savings has an opportunity cost…..not much interest. There may be more productive places for these excess dollars somewhere else.
The question is, how much is enough to have in savings? Here’s how I help clients think through this question.
I think there are 3 steps to the answer.
- The answer to the 1st step is how much is enough for emergencies. A good rule of thumb is between 3 – 6 months of living expenses.
- The answer to the 2nd step is which short-term goals you have that are coming up in the next 24 months that need to have money available to fund them without needing to take funds from an unreliable source such as the stock market or a source that is tied up with penalties and fees to access.
- Once you combine the 1st step and the 2nd step and look at the total, you can evaluate the third step…the feeling of safety. Sometimes people don’t feel safe with their chosen amount for emergencies and short-term goals. They would like to add an amount to this that helps them emotionally feel better. (This is somewhat dangerous as it’s hard to answer the question how much is enough to truly feel secure, but it still has a place in calculating the total).
As an example, an individual who has $5,000 per month in ongoing living expenses and needs to fund a vehicle within the next 6 months (for $25,000) might keep $50,000 in savings. They calculate this by taking the $5,000 per month expenses and multiplying it by five months ($5,000 x 5 = $25,000) then adding to it the short-term goal of the vehicle ($25,000) for a total of $50,000.
Another example may be a couple who has monthly living expenses of $8,000 and a wedding fund of $30,000 in 12 months. Their savings reserve might be $60,000. They calculate 3 months worth of expenses at $8,000 per month ($24,000) and add the 30,000 wedding goal for a total. To their total of $54,000, they add an additional $6,000 for “security”.
These cash reserves can be kept in a high-yield savings account.
How do you determine how much is enough for savings?
If you have any questions, Please feel free to contact me.