New Money Rules for Financial Security - #2. Building Cash Savings

[This post is written and copyrighted by FIRE Finance (http://firefinance.blogspot.com).]

In continuation with our contemplation on the basic rules of money for attaining financial security, today we examine the importance of cash savings and emergency funds. In a deflating economy, unemployment is high. Most businesses go into an expense trimming mode and pink slips are a norm. In such a scenario how do we manage to keep our financial security intact in case of a loss of a stable cash inflow?

Rule #2: Cash

Old thinking: Keep enough money in ultra safe accounts to cover life's emergencies, but no more.

New rule: Relying more on cash can rescue you in an "asset emergency."

Our take: We faced the impact of an economy in recession when we were handed the dreaded "pink slip" one fine morning in a well kept surprise move from our employer. When we inquired into the reason behind this act, we were informed that it was a business decision. Our position was removed in an effort to trim expenses due to a tight budget. We are sure that many Americans have heard similar responses when they were shown the door. After all, the primary goal of any company is to stay in business. And they will do everything they can to remain afloat and improve their bottom line.

Thankfully we had successfully built an emergency fund which had about 8 months' worth of our living expenses. This fund protected us from an immediate financial disaster. You can say it was one of the most practical personal finance advices that we've implemented in our lives. More so, since a falling market had erased about 50% of our portfolio. In addition, we have also saved cash for some unavoidable big ticket expenses which are in the horizon for next two years. Now we are considering how we can trim our expenses further to stay afloat longer.

Cash is really king in a recession. With flooring real estate prices and a tumbling stock market, we cannot use our home equity or stocks to pay our mortgage in case of a job loss. So our take is to build to a comfortable cash fund for emergencies and must big ticket expenses in the near horizon before putting money into our portfolios for our nest egg.

Rande Spiegelman, Vice President of financial planning for the Schwab Center for Financial Research, recommends looking at the next one to three years and adding up any big-ticket stuff you see coming: tuition, a wedding, a down payment on a house. Once you have your total, aim to hold that much in a cash account or a low-risk investment such as a high-quality short-term bond fund.

Once the cash fund is in place, our next goal is to protect the principal in our portfolio (nest egg) by tweaking our asset allocation. It'd pay off to put our hard earned dollars in short term bonds or fixed rate Certificate of Deposits and watch the market carefully. We like Warren Buffet's advice of watching the game from the sidelines till we understand it better. Speculation without an iota of understanding means disaster.

If we are nearing retirement, cash becomes even more important when the stock market is providing low returns. Common sense tells us to have at least two years worth of living expenses in low risk investing instruments. The rest remains the same: trim expenses, watch the market and tweak the wheel of asset allocation according to our needs and the momentum of the market.

Question

What are your views and experiences about building cash savings and emergency funds with respect to keeping your financial security intact in the immediate present? We are looking forward towards your feedback.

Series

New Money Rules for Financial Security
» Rule #1 - Handling Risk
» Rule #2 - Building Cash Savings
» Rule #3 - Earning Potential
» Rule #4 - Handling Debt
» Rule #5 - Home Equity
» Rule #6 - Diversification
» Rule #7 - Retirement

Image Source(s): iStockPhoto

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