Financial experts everywhere have hinted at the need to save money for a “rainy day” or an emergency fund, but how much money do you need to have on hand? The truth is, there is no right or wrong answer; it really depends on what you need the money for. If you’re talking about emergency cash on hand, having 2-3 months of expenses is wise. If you’re asking about literally carrying cash, don’t carry more than you can afford to lose.
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Physical Cash vs. Liquid Assets
Physical cash is any kind of money that you have on your person. You don’t need to access an account to make a withdrawal or do anything special to use it — it’s simply cash on hand. Similarly, liquid assets are something you can quickly convert into cash without losing any market value. While cash is considered to be a liquid asset, having physical cash on hand is the easiest form of an asset to spend. Things that take time to convert into cash, like cars or real estate, are not considered to be liquid assets. Some of the most common examples of liquid assets are:
Cash for Emergencies
Having money set aside for an emergency is a good idea. If and when an emergency occurs, you are prepared to handle it. Some great examples of why you would need emergency cash at the ready include:
- Car expenses.
- Loss of a job.
- Major home repairs.
- Natural disaster damage.
- Unexpected medical bills.
- Last-minute travel.
- Freedom to pursue investment opportunities.
- The ability to put money down and have more leverage for making big purchases.
If you find yourself asking the question, “How much cash should I save for an emergency fund,” conventional wisdom says you should have $1,000 saved up. While that’s certainly a great start, keeping $1,000 on hand isn’t always a possibility. Ultimately, what you put away in an emergency fund should be based on your fixed income.
To answer the question, “How much cash should I keep on hand for emergencies,” you should analyze your budget. If you don’t already have a budget plan in place, then it may be hard to figure out how much cash you should have on hand. To create your own budget, start by determining how much income you make each year. Then analyze how much your monthly bills are, leaving plenty of room for living expenses and savings. What’s leftover is a good amount to have on hand.
While it’s always a good idea to have money on hand, there are some cons that come with carrying cash. For example, you run the risk of having the cash stolen or misplacing it. Similarly, if you’re not storing your money in a banking facility, you’re missing out on allowing your money to work for you and gain interest.
Where to Stash It
The point of emergency funds is liquidity, or in other words, easy access to money on short notice. Many people choose to keep their emergency fund on-hand in their own home so that they can access it with ease. While that certainly makes sense, keeping these funds in your home doesn’t allow them to accrue interest. Because a checking account allows you to access your funds whenever and wherever with a debit card, you can also keep your emergency funds in a checking account.
High-yield savings accounts are another excellent place to stash your emergency funds. It’s still easy to access your money when you need it, but you’ll also be earning interest. Opt for an option that has little or no monthly fees or balance requirements and a competitive interest rate.
Money market accounts are another great place to store your emergency funds. Like a savings account, a money market account accrues interest but at a higher yield. Certificates of Deposits, or CDs, are yet another option for storing your emergency funds. CDs can tie up your money, forcing you to pay a fee if you close an account early, but you can combat this by laddering your CDs. This means setting a shorter term for multiple CDs with different maturity dates so that you always have access to cash.
How Much Is Too Much?
Once you’ve reached your savings goal (whatever it may be), you can continue to add to your emergency fund, but there are also a wealth of other options you can use that money for. For example, once you’ve hit your goal for emergency funds, you can reallocate the money you were saving and contribute it to a different kind of savings account, such as that offers more interest. You can also put those funds towards investment goals. To get better returns, be smart about the extra money you have on hand.
A checking account is often referred to as “cash” because of how easy it is to access your money. To answer the question, “How much cash should I have in a checking account,” most people follow the 50/30/20 rule. This dictates that 50% of your after-tax income should be spent on needs, 30% spent on wants, and 20% allocated into savings. Needs are essential expenses like bills, groceries, insurance, and health care. Wants are unnecessary things like high-speed internet, vacations, electronics, and entertainment. Your savings can be anything from an emergency fund to an IRA contribution, savings account, or stock market investments.
What About a Savings Account?
A savings account is another safe place to keep your emergency money. Unlike having literal cash on hand, a savings account adds security to liquidity. Plus, keeping your emergency fund in a savings account allows it to collect interest. Depending on the type of savings account you keep your emergency funds in, you can earn an average of 0.9% back on what you put in.
Carrying Cash vs. Cards
More often than not, people pay for purchases with their cards. It’s safer than carrying cash around all the time, but many people often ask, “How much cash on hand should I have?” It’s always a good idea to have some cash on hand to spend. Consistently paying with a card can be detrimental to your checking or savings account because it doesn’t feel like you’re actually spending anything. Unlike handing a bunch of cash over, simply swiping a card doesn’t force your brain to reconcile how much you just spent. This can quickly lead to overspending.
In addition, you can’t always pay with a card. Some retailers do not accept certain types of card payments, and others don’t accept card payments at all. Avoid this problem by planning ahead and always having some amount of cash on hand to spend at locations where cards aren’t accepted.
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