In a Cash Emergency, Are You Prepared?
Planning--not panicking--is key to long-term strategy.
You need money. The roof is leaking. You have to pay a supplier, and your customers have been late paying you. Your delivery truck is on the fritz and you need it repaired--fast.
There are countless reasons you might need emergency cash, both for personal reasons and for your business. Rather than panic or use a high-interest credit card to pay unexpected expenses, the best plan is to have a stash of cash--an emergency fund.
"Cash is always important to have, whether it's for an emergency or an opportunity," says Michael Dubis, a certified financial planner with Michael A. Dubis Financial Planning in Madison, Wisc. "With cash, you can always act prudently without stress."
Just the thought of amassing thousands of dollars can be stressful, sure, but you shouldn't let that stop you. Here's why, and how, you can make an emergency fund a priority.
Why an Emergency Fund?
Life is made up of "what ifs." An emergency fund will help you be prepared.
"You always need to have funds available for those unexpected happenings," says Diahann Lassus, a certified financial planner and certified public accountant with Lassus Wherley in New Providence, N.J. "If you don't have an emergency fund, you could end up increasing your debt, or having to pay late fees because you can't make ends meet, or you may not be able to pay for really important things."
Business owners have to consider both the needs of the business and their own personal needs, she says.
A personal cash reserve is essential if you have your own business, especially in this economy. You may need to pay for basic living expenses if your business suffers and you give yourself a salary cut to leave more money for the business's needs.
From a business perspective, it's ideal to have a credit line that can be tapped for emergencies and to help level out cash flow over time. Without a line of credit, Lassus says, the business can build a cash reserve, but this can be harder and can involve a significant amount of money, depending on the size of the business and the critical payments that would be needed to keep the business moving.
How Much To Save?
How much you need depends on how much you spend and the reliability of your income sources.
The general answer is that families should have between three and six months' worth of living expenses in an easy-to-access account.
But for the personal finances of an entrepreneurial family, the stability of the business must come into play.
"The entrepreneur's income is likely to be volatile," Dubis says. "I often recommend small-business owners have one year's worth of lifestyle expenses set aside, especially if they rely on the small business for health insurance.
If one spouse works in the business and the other has a stable job outside of the business, six months' worth of expenses may be sufficient.
It's a lot harder to calculate how much cash a business needs to keep in reserves.
Dubis recommends between three months and a year's worth of expenses for a business emergency fund. The money can be used not just to supplement a volatile income stream, but it can also be used to allow a company to target opportunities. The extra money can simply carry a company if they're in a cyclical business.
Once you've decided how much you'd like to save, you need a place to put it.
These funds are not meant to ride the stock market or earn very much in interest. The goal is for the money to be there, liquid and available, when you need it.
Look at money market funds, savings accounts and short-term Certificates of Deposit (CDs). Shop around online for the highest-paying interest rate, or if you have a relationship with a bank, you may get a decent offer locally.
But be careful, and stick to the simple stuff.
"Many banks have brokers on staff who might try to steer you into some commission-laden crap," Dubis says. "And stay away from anyone telling you that you can get more return with no risk. Most of the things brokers are calling 'better' are lipstick on pigs."
Dubis shares the story of one client who was told by a broker he could provide a product paying almost five times higher than the going yield on risk-free products. Dubis says that was bunk: The broker was selling an investment that had up to 40 percent of its assets in low-rated bonds, and it lost 12 percent in just a few months during 2008.
How To Get Started
If you don't have an emergency fund, you need to start small.
This is one of those times when the phrase "pay yourself first" is critical to success. Set up payroll deduction or an automatic savings plan so that your emergency fund contributions are made before you have a chance to spend them.
Make it part of your budget or spending plan, or consider it a non-negotiable expense.
"If you can get those dollars out of the 'spending' account, the probability of success will be much higher," Lassus says.