If the past year and a half has taught us anything, it’s that having a good financial foundation is critical. While cash is such an important aspect of our everyday lives, many have become complacent about it, often overlooking it entirely as an asset class. Even if your priority is to grow your wealth, you need to build on a foundation of financial security. Cash is that foundation, offering you the comfort of knowing you can cover your monthly bills and unforeseen expenses.
With current interest rates so low, you may not even be thinking about your cash, but having a proper plan for it is a vital part of your financial health, and one that can add to your wealth in the long term.
As a financial planner who has helped hundreds of investors with their finances, I’ve seen a lot of money mistakes. One of the most common mistakes is clients trying to put too much of their wealth into non-liquid investments. While it’s tempting to aim for the biggest returns, this can lead to complications if unexpected events occur, like a job loss, larger-than-anticipated tax bill or even a global pandemic. Without easy access to cash, you may be forced to charge large amounts to your credit card or pull money from other accounts, incurring possible penalties or tax liabilities. You can avoid this simply by having a plan for your cash.
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The Basics: How to Make a Plan for Your Cash
I suggest structuring your cash in three tiers.
- The first tier: This layer is for your routine, recurring expenses. These are the predictable bills that come in every month. The amount you hold here is up to you: Some people keep the bare minimum and others prefer more of a cushion. Figure out the lowest number you’re comfortable with and make sure that amount is in your checking account every month.
- The second tier. This one is for larger planned expenses over the next 12-24 months, such as a car purchase, home repairs or a vacation. These are expenses you know are coming and can prepare properly for. Don’t be tempted to invest this cash while planning for these expenses, since it’s best to not take risks with money you know you’ll need. The goal should be to be able to pay for large expenses in full when the time comes. The amount of cash you set aside here may vary year to year, but these expenses are as important to consider as your immediate monthly expenses.
- The third tier. The last tier is your emergency fund, which should be enough to cover your expenses in the event you lose your job or experience another sudden expense. If you are younger, you may aim for three months of savings. If you are older or have a family, six months is ideal. This is money that is designed not to be spent, except in the event of a true emergency. Having this cash available can save you from financial catastrophe should the worst occur.
Where to Stash Your Cash
While tier one cash should be kept in a checking account, tiers two and three should be in savings accounts. Regardless of where you bank, you should consider leveraging online banks to earn the most on your cash. Online banks operate similarly to brick-and-mortar banks, just without the physical location. They’re FDIC-insured, and they have lower operating expenses, which means they pass along higher yields to you.
This will help prevent another common mistake I see, which is the acceptance of low interest rates. Because interest rates change so rapidly, it can be a full-time job to stay on top of the latest rates. A lot of my clients use MaxMyInterest, a cash management platform that automatically directs your funds from one online bank to the next based on which is paying the highest interest rate. This helps you earn the most possible on your cash while also keeping it liquid and accessible. While the money you earn may not be life-changing, over time it adds up – and I think we can all agree that earning more is better than earning less!
The Bottom Line
Cash may be less flashy than higher yield investments, but don’t underestimate its importance in building your wealth. If managed properly, your cash foundation should provide you with the safety and security to live comfortably. But if overlooked, it can be catastrophic to your financial well-being. Once your foundation is in place, you can then focus on building your wealth.
Whatever your income or stage in life, make sure your cash is working for you.
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