A common personal investing rule is to always have the value of six to nine months of living expenses in cash or cash equivalents before you begin investing. This makes sense because investment accounts typically fluctuate in value. This rule will help make sure that next month’s rent and grocery money is not subject to a 30% decline in value.
What is a cash equivalent? It is a “cash-like” asset; its value stays at or near what you paid for it regardless of what is happening in the economy and the financial markets. Examples include short term bonds and money market accounts.
Your circumstances will determine how many months’ worth of expenses you need to have put aside for the unknown. Here are some factors to consider:
- Number of Dependents
- Job or Income Stability
- Other Potential Capital and Income Sources
- Overall Financial Commitments
Your Security factor is another part of the equation. How much money do you need in cash to feel financially secure? If the answer is ten years’ worth and you are in the earning phase of your life, you may want to see if there is some irrational fear behind your answer.
No one can feel financially secure of they are wondering how they’ll pay next month’s bills. Creating financial security is an early and important step in your financial journey. Check to see how much money you have in cash equivalents; then check your personal cash flow statement to see how long that money would last if you needed to use it as your only source of income. Hopefully, this little exercise will give you financial peace. If it doesn’t, create a financial plan to change the situation to one that will.