How much is enough for an emergency cash reserve?

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After paying down debt, getting an emergency cash reserve is the next thing to do when building a solid financial base. The only exception to this is maxing out your 401(k). Always take advantage of your 401(k) match regardless of your debt or emergency fund situation.

What is the ideal amount for a cash reserve?
Everyone has a different standard of living, career, and tolerance to risk. With that said, the primary reasons for having an emergency reserve are the same. Firstly, we don’t want to damage our credit when tragedy strikes. Next, we don’t want to be evicted from our homes. Lastly, the added stress of financial problems isn’t worth it. Extra cash adds a ‘buffer’ that protects us from life’s unexpected ups and downs.

An emergency cash fund should cover:

  • Mortgage or Rent payments
  • Insurance costs
  • Utility bills
  • Groceries
  • Car payments
  • Student Loans
  • Minimum payment on credit cards

A standard cash reserve goal should cover six months of expenses. If your monthly expenses total $2000 you should plan on a cash reserve of $12,000. Six months is a starting point but there are other factors that you might consider. If your job is in high demand you might be able to lower your time from six months to three. The economy’s strength is a factor as well. In times of recession (or suspected recession) it might be wise to pull some money out of high risk investments and build your cash reserve.


Word of warning
While having cash handy for emergencies is a wise decision, too much cash can actually hurt you in the long run. There is a balance between cash and investments. Saving too much cash can undermine your investment and retirement goals. Excessive cash holding is risky in terms of opportunity cost. Opportunity cost is the difference between what you could have made VS. what you actually made. For example, an NBA basketball star could take over his families furniture store and make $100,000/year after graduation. On the other hand he could play for the NBA and make $10,000,000/year. The opportunity cost of taking over the family business is $9,900,000. That same idea of opportunity cost plays a big role in determining the ideal balance between cash and investment. A few percentage points makes a world of difference in terms of compound interest.


Where to keep your cash
Where should you keep your cash? Keeping your cash in an account that will keep up with interest is important. Stuffing money into your mattress isn’t going to keep up with inflation. With the Fed cutting interest rates the return on FDIC insured savings accounts have decreased from over 5% to 3.75%. While the decrease is unfortunate one fact remains; online savings accounts are still the safest (and most profitable) when compare to other alternitives — which aren’t FDIC insured. Read more about online savings accounts with high interest.

The CD Shuffle
If Certified Deposits (CDs) were more attractive right now this strategy would optimize the return on your cash reserve. Unfortunately CDs, according to BankRate, were all under what you could receive with an online savings account.

If the interest rates on CDs ever improve beyond online savings accounts you could use this strategy. The concept requires multiple CDs being opened with different expiration dates.

Your first purchase would include the following:

1 month CD (expires in 1 month)
2 month CD (expires in 2 months)
3 month CD (expires in 3 months)
4 month CD (expires in 4 months)
5 month CD (expires in 5 months)
6 month CD (expires in 6 months)

As a month passes your 1 month CD will expire. Take the money from that CD and buy another 6 month CD

2 month CD (expires in 1 month)
3 month CD (expires in 2 months)
4 month CD (expires in 3 months)
5 month CD (expires in 4 months)
6 month CD (expires in 5 months)
6 month CD (expires in 6 months)

As the second month expires take that money and buy another 6 month CD

3 month CD (expires in 1 month)
4 month CD (expires in 2 months)
5 month CD (expires in 3 months)
6 month CD (expires in 4 months)
6 month CD (expires in 5 months)
6 month CD (expires in 6 months)

After 6 months every one of the CDs will be 6 month CDs. As the CDs expire continue to buy new 6 month CDs.

6 month CD (expires in 1 month)
6 month CD (expires in 2 months)
6 month CD (expires in 3 months)
6 month CD (expires in 4 months)
6 month CD (expires in 5 months)
6 month CD (expires in 6 months)

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No Monthly Phone Bills

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In a previous post, Phone Service for Free, I wrote about the possibility of getting phone service for almost nothing. Well, I’ve done it. I’ve taken the plunge and won’t be paying any monthly phone bills.

These are the steps I took to save over $1500 a year by cutting out my monthly phone bill.

Step 1- Buy and Test the MagicJack

If you haven’t read my previous article on MagicJack here’s a summary. MagicJack runs off your computer’s internet connection. It’s a USB to phone jack converter. You get a local number. Every call within the United States is free. It costs $39.99 the first year and is only $19.99 a year from then on. There are no taxes, fees, or other extra costs.

We thought it best to test the MagicJack before we made big changes in our phone setup. To our delight it works very well. We decided to take the leap.

Note – Part of testing the MagicJack involved buying a portable phone system with multiple handsets. Those type of phones require a single phone jack connection and we place the extra headsets around the house.

Step 2 – Cancel the regular phone line

We’re finishing our basement and I rewired all the phone lines. The old lines were broken or poorly wired so I upgraded the wiring. Before we finished the Sheetrock I wanted to make sure the future owners of the house would have a working phone line. For a few months we had a regular phone line. Their cheapest service was $11.00. That’s not bad. But when the bill came it was $28.00/month; almost three times more because of taxes and service fees! We’d gone without a land line for years without any problems so this wasn’t a hard decision.

Step 3 – Switch to prepaid cell phones

The contract on my cell phone was set to expire within a month of testing the MagicJack. Because I have a young family I thought depending completely on the MagicJack would be a bad idea — for safety reasons. After shopping around for some prepaid plans I found that Cingular had the best option for a prepaid phones. If you buy $100 of prepaid minutes they don’t expire for a whole year. Other prepaid phones have minutes that expire. Cingular also has the option of unlimited mobile-to-mobile within the Cingular network. This plan works great for my situation and I get to keep my old number.

I will still carry my cell phone. Without any cost I can see who’s calling me and call them back from a land line. The added safety and convenience of having a cell phone will come in handy from time to time. By turning off my cell phone I’ll save an extra $90 a month.

Summary

I will save $130 a month with this new setup.

Besides saving money the other added benefits are:

  • I don’t drive and talk on my cell phone anymore. This happened infrequently but was still dangerous
  • It encourages me to plan ahead and make lists
  • I don’t have to wait for the weekend or 9:00 PM to talk with unlimited minutes

The total cost of everything is Magic Jack — $40, Prepaid minutes for my phone — $100, Portable phone system — $50. Next year I’ll only pay $20 for the MagicJack and $100 for the prepaid minutes.

This year I’ll save close to $1500. Next year it will be slightly more. If you have any questions or comments please leave a note below.

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