“When is it okay to use my cash reserves?”
That’s a big question since we’ve all been told to save, save, save since birth, right? You’re doing your best to save for a rainy day, but sometimes your cash reserves start to look pretty attractive for use now.
Damn fine question. Let’s get to answering it so you have the best information to help you make the best decision for your specific financial situation.
What guidelines should I use for building my cash reserves?
Life happens at the speed of life. Sadly, expenses don’t come along when we’ve got the right size nest egg in place to absorb the impact. Setting a goal of $1,000 to $2,000 in your emergency fund is a good place to start. This gives you a soft(er) place to land when inevitable emergencies should come along. Once you get those funds in place, many experts at Time Money recommend working up to cash reserves of three to six months worth of expenses in your rainy day fund, as a general best practice. This makes your soft place a whole lots softer, taking the stress out of wondering where the money will come from when life happens.
What kind of life events can I use my cash reserves to fund?
Now that you’ve gone through the effort of socking away cash for a rainy day, it’s bound to rain eventually, right? From making the down payment on a home to getting a new car and moving across the country for your dream job to funding that dream vacation with your partner, your cash reserves have endless potential.
When it comes to less fun life events like repaying credit card or student loan debt, it’s important to consider those expenses as part of your regular monthly budget. As you’re crunching your numbers to determine how much to set aside for cash reserves, it’s important to make sure those expenses are being covered outside of your cash reserves/emergency fund.
The most important thing about your cash reserves is that you feel confident about what you have socked away and, should you make the decision to tap into them, you’re getting a return on your money that brings you to a better place emotionally and financially. Let’s have a look at some times where tapping into your reserves might make more sense than putting more money away.
How do I know when to use my cash reserve?
Sometimes life won’t give you a choice. Water heaters, medical bills, and other financial emergencies tend to crop-up out of the blue. That’s why they’re called “emergencies.” These situations are why you have cash reserves in the first place. But what about those life situations where you’re trying to decide if using your rainy day fund is a good idea?
If you’re considering paying off debt with your cash reserves, look at your interest rate on your debt as well as the rate of return being earned by your cash savings. If your debt’s interest rate outweighs your return on investment for your savings (say a $2500 credit card tab at a 16% APR versus $2500 in your savings account earning you 1% annually) this is an ideal time to use your cash reserves. It’s also an ideal time to use money you might put into your cash reserves to pay down your debt instead. As an example, if you just paid the $50 minimum payment each month on that 16% APR credit card, it would take you 83 months and a whopping $1647 in interest to pay off that debt. By taking your $2500 out of savings and wiping out your credit card debt in one swoop, you’re saving yourself $1647 in interest and only losing out on $25 in interest. This is a net gain of $1622. Not too shabby, eh?
Now, when it comes to making a downpayment on a house or even a new car, how do you know when to use cash reserves? Sit down and work out the payment savings each month. How much will increasing your downpayment lower your monthly mortgage payment? Will this lower payment offer you more flexibility each month or is the difference negligible? Would you be depleting your retirement savings to make this larger downpayment, and if so, would that cause you more or less stress?
Answering these questions can help you answer whether you should tap into your cash reserves or keep putting money into savings. There’s no downside to accumulating a rainy day fund, but sometimes that money can reduce debt and stress and put you in a more powerful financial situation to save for the future.