Most of us understand the importance of saving for a rainy day, but sometimes it takes a crisis like the current pandemic to make us act on it.
With so many jobs lost and the outlook unknown, having a cash buffer means you are more able to manage unexpected expenses or the loss of regular income.
While it might be more challenging to establish a cash buffer in this current crisis, it does underline the importance of making sure you are not living from one paycheque to the next.
For those in a position to save, it’s still important to have cash reserves that can be accessed at short notice. So how much is enough to provide a reasonable level of short-term financial security? The answer will depend on whether you are still in the workforce or retired.
While you are working
Some say the equivalent of three months’ pay is a good start for those still working. Others simply put a figure on it, with $10,000 often suggested.
So, what is the best way to work out what is right for you?
Firstly, calculate your monthly expenses. How much do you need to cover your mortgage, utility bills, phone and internet, insurance, food, transport, health insurance and childcare? Once you know what your commitments are, then you are in a better position to budget for that rainy day.
Consider monitoring this expenditure for two to three months to allow for quarterly bills and other one-off commitments.
Build your cash buffer
The next step is to decide how you will achieve your cash buffer. There are various savings methods.
One of the easiest is just to take an amount – either a percentage or a fixed sum – automatically out of your salary each month or each pay cycle and put the money into a separate account. After all, what you never have, you never miss.
Or if you have a mortgage, you could consider putting the money in a mortgage offset account or redraw facility. That has the added benefit of helping pay off your mortgage faster, but you need to be disciplined not to touch your savings.
Now that you know your expenditure, look for new ways to trim some fat to help reach your savings goal sooner. Realistically to build up your buffer quickly, you would need to save a minimum of $50 a week. Even then the figure would only be $2,600 at the end of the first year.
Tax refunds or other windfalls such as inheritances could be put directly into your savings fund.
If you are retired
The landscape changes once you retire. Rather than needing just three months as a buffer for emergencies, you probably need a longer time frame. Some say you should have two to three years of cash, although 12 months is more often suggested.
Having ready cash available in retirement means you are less likely to have to sell growth assets like shares to cover your living expenses. This is particularly important if selling coincides with a falling sharemarket.
One strategy is to employ the bucket method, where you split your savings into three separate buckets, each for a different time frame.
A bucket strategy
The first bucket is to provide money for the first two to three years of retirement. This money should be held in cash investments so it is easily accessible.
The second bucket is for the medium term. Its key role is to top up bucket number one. Investments here should still be quite conservative, perhaps low-risk quality stocks and/or bonds.
The third bucket is where you take more risk to cover your longer-term living expenses. This could be investments in local and international shares or other growth assets. As a result, the balance may fluctuate from year to year, but over time it should continue to grow so you don’t run out of money.
To help maintain your savings, the government has also temporarily halved the minimum amount you are required to withdraw from accountbased superannuation pensions and annuities for the 2020-21 financial year. The minimum percentage payment is determined by your age. Never has a cash buffer been more important, so contact us if you want to discuss a strategy that works to future proof your finances whatever the future holds.