How-To Guide: Create a Cash Cushion

By Motley Fool Staff
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Emergencies happen. You might as well plan for them. Whether it's a temporary job loss or an unexpectedly high orthodontist bill, having some cash on hand will cushion the financial blow.

Creating a cash cushion for planned expenses is a good idea, too. So to help you on the path toward financial stability, follow this four-step plan, and start saving!

1. Consider your risk and responsibility.
Do you have extra mouths to feed or preschool tuitions to pay? Is your job stable, or is your industry going through a hiring lull? Your answers will help determine how thick your cash cushion needs to be.

2. Figure out your essential expenses.
You've probably heard that you should have three to six months of expenses set aside for an emergency. That rule of thumb is a good starting point for your calculations, but you might need less than that -- or more. It'll take just 10 minutes to come up with your exact emergency savings amount. Use the PDF-format "Set Two Savings Goals" worksheet for this step and the next one.

3. Calculate your short-term cash needs.
Your cash cushion also includes money you'll need for expenses coming up in the next three, five, or seven years, depending on your risk tolerance. (You don't want this money in the stock market. Trust us. Stocks are too volatile to risk your short-term cash.) The "Set Two Savings Goals" worksheet will also help you assess your upcoming cash needs and come up with a monthly savings amount to meet them.

4. Get the best return on your emergency savings.
Mingling your emergency and short-term savings with your checking account puts your savings at risk. Instead, keep this money separate -- and get a better return on your cash while you're at it. The "Put Your Short-Term Savings to Work" worksheet (also in PDF format) will organize your savings-account shopping -- taking into account liquidity, interest rates, risk, and account costs -- so you can find the best return for your bucks.

For more on padding your cash cushion and preparing for life's curveballs, see:

Seeking a high-yield account for your short-term savings? Our Banking collection has all the information you need.

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  • Report this Comment On July 26, 2009, at 8:12 AM, LGFFool wrote:

    Good article.

    People are still reading advice on building an emergency savings fund with 3 to 6 months of expenses or 6 months of expenses. That kind of advice is 1980s or 1990s advice. It won't work well today.

    The world has changed. If you think you should have that little savings today, you may be lost. We are recommending that for today's economy you should build 15 to 18 months of expenses in emergency savings. The first six months should be in liquid money market savings with the best interest rate you can get.

    If you lose your job today, it is going to take longer for you to replace your income. A cash cushion of 15 to 18 months is what is needed.

    You can join our free Facebook group "Live The Lifestyle Your Family Deserves" by searching Facebook for the group and clicking on "become a fan" for instant access to our free blogs on personal finance.

    Also: Check out www.middleclassmoney.com if you are interested in really getting ahead in today's economic environment.

    Thank you.

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DocumentId: 606036, ~/Articles/ArticleHandler.aspx, 11/24/2009 4:31:31 PM