How to Manage Your Emergency Reserve

Know the RulesWhether you are currently establishing your emergency reserve or your reserve is fully funded, it is important to manage your reserve account for maximum effectiveness. There are “rules of the game” you should follow so your reserve account can serve the purpose for which it was created. Remember, the primary purpose of an emergency reserve is to provide a cushion to protect you and your family in the event of an unforeseen and unexpected financial emergency.

The Primary Considerations

safety-firstTypically, any time you have non-committed, or discretionary, money you want to put that money to its highest and best use. There are many things that can determine the highest and best use, but the four primary considerations are 1) Safety, 2) Liquidity, 3) Return, and 4) Tax Treatment. I define safety as minimizing or eliminating the potential loss of your money. I define liquidity as the speed and ease with which you can access your money. I define Return as the interest or growth your money receives. And finally, I define Tax Treatment as the method of taxation your money could potentially be subject to.

The money designated for emergency reserves should be kept in its own account separate from any other monies. Of primary importance is the Safety and Liquidity of the money. Return and Tax Treatment are NOT a consideration for these funds. This money must be free from risk and protected from loss and is not to be invested in any type of investment that does not guarantee the money or limits access to the Return OF My Money Quote - Will Rogersmoney. This money should be placed in a basic savings account or a money market account, despite the temptation to get a return of some kind. As Will Rogers once said, “Return of my money is more important that Return on my money!”

Staying Focused

At the time I wrote this, a basic savings account is paying a return of 0.01% and a typical money market account is paying between 0.03% and 0.05%. In order to increase your rate of return you may be tempted to invest the money in a CD, which may increase your return to 0.15% to 0.55%. However, in order to increase the Return on your money you will generally have to sacrifice Safety, Liquidity, or Tax Treatment, and in this case it is Liquidity. The bank will require you to commit your money to them for a longer period of time in exchange for a higher Return. If you sacrifice Liquidity and an unexpected expense arises you may not be able to access your emergency reserve without some type of penalty. That would defeat the whole purpose of the reserve account.

Seeing the Not-So-Obvious

Hidden BenefitsBut don’t fret over it because there is a Return on the emergency reserve. You just may not realize it because there are both seen and unseen benefits to an emergency reserve. The seen benefits are the Safety and the Liquidity of the money, as well as the money itself. The unseen benefit is the money you may be able to save by having the reserve. For instance, with the fully funded emergency reserve you can comfortably increase the deductibles on your homeowners insurance, auto insurance, and even your medical or health insurance. That will typically result in lower insurance premiums. In essence, this newfound money should be considered Return on the reserve because its very existence has enabled you to keep more of the money you already earn. Return is also realized in the interest you save by not paying interest to the credit card company for use of their money as a reserve. Probably the most important benefit is the peace of mind you feel knowing that you are prepared in the event you run into one of those financial perfect storms in which a job loss is followed by a leaky roof and a new transmission in the minivan.

Keeping on Track

If you find yourself in a situation where it becomes necessary to use the reserve to pay an unbudgeted or unexpected expense, your top priority should be to replenish the reserve account as quickly as possible. Begin making minimum monthly payments on all of your expenses and redirect every available dollar to funding the reserve. Remember, it is more important to establish and keep an emergency reserve than it is to send money toward any outstanding debts.

There are many financial strategies that you can use to improve your financial profile and the emergency reserve is just one of them. If you would like us to introduce you to more of the strategies that can dramatically improve your financial health call us to set a time to talk.

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