Rainy Day Fund Tips

Check out the latest advice about piling up a rainy day fund and where you should keep it.

Rainy Day Fund Tips

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Cash flow problems? One thing that can take some of the pressure off cash flow is having adequate reserves to call on for unexpected expenses or to tide you over if revenues take a dip.

In fact, the principle of having a reserve fund applies just as much to your personal finances as to your business. So you might want to read this with an eye on both sides of your fiscal life.

A word, by the way, about what we really mean by cash reserves: Sometimes people confuse the concept with “petty cash.” That’s not just confusing apples and oranges. They’re so different that it’s more like a comparison of apples with barbecue.

“Petty cash is nominal funds used to meet occasional yet immediate needs,” says Jim Herst, CEO of Perceptive Selling Initiative in Highland Park, Illinois. Many offices have a cash box that personnel can use for small, immediate purchases — stamps from the post office maybe, or a pizza lunch on the last Friday of the month. Those funds need special recordkeeping procedures just to keep track of where it’s all going.

Reserves are something else entirely. “Reserves — also thought of as emergency cash — are specific funds held to meet determined risks,” says Herst. How much do you need to salt away in reserves to cover those “determined risks”? Herst observes that it takes experience to answer that question.

One approach is to simply set aside a time period in which you could keep paying bills if your income – or revenues – suddenly took a dive. And that’s the reasonable starting place whether we’re talking about your business or your personal finances.

You will need to rank your expenses in order of necessity to your business as well as in order of which needs to be paid off most promptly.


As always, nothing in this column can substitute for the considered advice of a trusted professional financial adviser. Every personal and business situation is different, and only a trained and certified professional has the expertise to guide you specifically in the decisions you need to make.

On the personal side, financial planners generally recommend parking three to six months’ worth of cash in a safe and easily accessible account. Of course, you can’t just make that appear out of thin air – you’ll need to work up to it bit by bit, and exercise discipline so you don’t dip into those resources.

“Cash flow and emergency reserves are one of the first topics we cover for a financial planning talent,” says Rob Schultz of NWF Advisory in Encino, California. Schultz says that the three-to-six-month rule of thumb can vary considerably based on other factors.

“I would typically skew to a lower savings reserve requirement for a family with two stable incomes,” he explains.

And stability is a key point. “I deal with a lot of health care professionals, and we consider them fairly stable in terms of job stability – especially those who work for major institutions and hospitals,” Schultz says.

But his Southern California client base also includes professionals in a very different field: entertainment. Performers – TV actors and others – “might have a show canceled at any time,” he continues. For them, “We set the goal at around one year of expenses to set aside in savings.”

Homeowners can consider an undrawn-upon home-equity line of credit as a partial alternative to a cash reserve fund, he adds – but not a replacement.

Equity lines of credit would be “an additional layer beyond the first three months in the bank,” Schultz points out. They’re attractive “especially for clients who want to feel like they have a large cushion but hate earning nothing in the bank.”

There is a caveat, though, with an equity line: Even if you don’t draw on it, under the wrong circumstances it can be here today and gone tomorrow. In a major economic downturn, banks can rescind or clamp down on the value of an equity line, “like we saw back in 2009 and 2010,” Schultz says.


In Business

On the business side, Schultz says, “The principle would be similar, but the factors that go into making the decision are completely different.”

Key questions, he suggests, would be the variability of cash flow and how easy or difficult it is to convert assets to cash if you need to – the liquidation value of your inventory.

The steadier and more stable your continuing revenue stream is, the less you have to keep on hand in reserves. On the other hand, if you rely on a few large contracts and any one or more of them could go to another competitor at any time, you’ll want to consider putting more aside.

“Just as an individual would have access to a home-equity line, a business would likely have a line of credit, and that would also factor into my decision,” he adds.

At the same time, though, you don’t want to draw on it too often or too deeply – just as you don’t want to run up bills on a personal credit card over the long term.

While a large inventory that you can sell off quickly can serve as another form of money in the bank, it’s not something you want to have to do every three months or so. Liquidating inventory isn’t a last resort, but it should be considered close to it.


Safe Keeping

That leads us to the second big question about reserves – where do you keep them?

Standard advice has always been to keep it in an ordinary, federally insured savings account. Financial experts are revising that advice in this day when savings interest rates are minuscule to nonexistent.

Schultz says that for the first three months’ worth of cash, “the bank is convenient, easy and safe.” So stick with that.

But the further out on the horizon you go, the more you can consider some other options. Of course, you’re not going to stash your emergency reserves in a high-risk stock fund that has a potential of double-digit returns – but also could collapse tomorrow.

Schultz favors short-term municipal bond funds for his personal financial planning clients, and that can be a reasonable choice for businesses, too.

It’s true that there have been worries in recent years about increased risk in municipal bonds – either sudden reductions in interest rates or even total default.

While those risks remain relatively low, you’ll need to get advice that is as unbiased as possible in making the right selection.

“We use very short-duration funds on the lower return end, but also with less interest rate risk,” Schultz says. “The default risk is negligible.”


Easy Access

In the end, though, the easiest answer to the reserves question is probably the safest: Keep as much as you can, up to perhaps a year’s worth of expenses. And keep the funds where you can get at them easily and where your risk of losing the money is minuscule to nonexistent.

That alone should help you sleep better at night, so in the morning you’re ready to make more money – and put more aside as you grow your business.


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