Thursday, April 05, 2007

Having a cash reserve

A lot of investors tend to think they can make a quick buck just by investing in the market. Many think that they should be saving for retirement no matter what the issue. One of my standard beliefs is that investing requires more than just the desire to save for the long-term goals, but that all individuals need a cash reserve before they should even consider it.

The main reason behind this is that if a problem should arise that requires you to come up with some cash you just cant get it fast enough if it is tied up in a retirement plan, or it is going to be costly to have your reserves in a long-term investment vehicle if you need it now.

The cash reserve is you foundation to be an investor. I recommend that everyone has at least 3 months and as much as 6 months of available cash just in case of an emergency. When I say 3 months I mean that you should have done a budget and determined what your expenses typically are for a 3 month to 6 month period and have that money in places you can get it not only fast, but with out penalty.

Now you don't need to have all this cash sitting in a low interest savings account and waste the interest, but you should have it in some sort of tired plan. One to two months in an extremely liquid account such as a bank account, or if it is available a couple months in a higher interest money market account that allows you to write checks. The rest can be locked up a bit for higher interest, but only in investments that don't charge a penalty for early withdrawal. CDs, stock market certificates, etc. The only penalty you would lose in these investment vehicles would be the loss of accumulated interest for the term, but not fee to withdraw the money early.

Emergencies for a new fridge, sudden loss of a job, a major vehicle repair, etc. are all reasons that you need this money liquid and in places that will not be penalized when withdrawn. It's bad enough that you have to spend the money, but it is even worse when you have to pay to spend it in an emergency.

If you own a home you can also lower the amount of cash you need on hand by getting a line of credit at the bank on your home. Even with this available line it is still smart to keep at least 3 months of expenses since you are going to have to pay interest on any money you borrow.