A rule of thumb for both businesses and individuals is to have at least three to six months’ worth of expenses in cash on hand.
For a CFO (Chief Financial Officer), cash can be as important as profit. Without cash, business operations won’t be able to continue.
When startups fail, liquidity is often the primary cause; meaning, they run out of cash. For more established businesses, as the costs to recruit and retain top talent increase, cash management becomes more important. Outside influences, such as inflation, can increase costs, adding additional pressure on cash management.
Just as cash is paramount for businesses, it’s the same for individuals and families. Everybody needs cash, but Americans are failing in this area. Almost two-thirds of Americans are living paycheck-to-paycheck. Essentially, that means they’re broke. To make matters worse, 45% of Americans have $0 cash on hand, and almost 70% have less than $1,000. This is a massive problem.
We don’t control what happens to us, only how we position ourselves and how we respond to adversity. Having enough cash on hand positions us to withstand emergencies. Failure to prepare leaves us extremely vulnerable.
My goal is to help you position yourself for financial success by establishing the proper amount of cash on hand for your situation. As a financial advisor, I’ve been helping people create financial security for over 20 years. I’m honored to be named to Investopedia’s list of the top 100 financial advisors many years running.
Here’s what we’ll cover:
- How much cash on hand should you have?
- Initial steps to take
- Getting to six months of cash on hand
- Cash versus credit
Let’s get started.
How much cash on hand should you have?
I mentioned at the beginning that it’s a rule of thumb for both businesses and individuals to have at least three to six months’ worth of expenses in cash. What do you think about that? Is that too much? Is that not enough?
It intellectually makes sense, but only 5% of Americans have between $10,000 and $20,000 in savings. How much do you currently have? How much would you like to have?
Big picture, I want you to become wildly financially successful. I want you to have whatever you want in life. But that will never happen unless you first find financial security. You get financial security by saving up six months’ worth of expenses.
My perspective on this has changed pre-pandemic to post-pandemic. I used to think three months was good enough. Today, I encourage everyone to get to six months. Once you get that saved up, you’ll have financial peace of mind. And that’s one of the most valuable things you can ever have.
I’d like you to commit to making that happen in your life.
Initial steps to take
So how do you get there? Before I go any further, know this; it won’t be easy. Six months’ of expenses is a lot of money. There’s a good chance you’ve never saved that much money before. Because of that, you’ll need to get focused and create a plan for making it happen. Here are the initial steps you’ll need to take:
In order to live how you want, you have to know how you want to live. Goals help us clarify what we want. When we take the time to think and write them, we dramatically increase our chances of reaching them. It’s also important to take a comprehensive approach to goal setting. Think about every aspect of life, not just money. In service of helping you do that, you can access our Goals course for free.
Goals are what you want, values are how you get there. Values help us set our priorities. They become the lens through which we view the world, and how we decide how to allocate our most valuable resources of time, attention, and money. To help you define yours, you can access our Values course for free as well.
Few of us know how much money we earn, and how much we spend. This needs to change. In order to become financially successful, you need to pay close attention to your cash flow. You do this by reviewing the previous 12 months’ of financial transactions. Log at to every financial account and look at each transaction. You’re looking for expenditures that shouldn’t be there, or things you’re paying for that you no longer value. I bet you’re going to find a good number of things you can easily cut out.
Without a budget, you’ll have little chance of becoming financially successful. A budget is a plan for your money. It will help you know when you’re on track to meet your goals, and when you’re behind. When you know how you’re doing, you can respond accordingly.
Getting to six months of cash on hand
Once you’ve gone through the review of your cash flow and created your budget, you’ll know how much your monthly expenses are. From there, you can put your plan together to save the money. For example, let’s assume your monthly expenses are $3,000. Therefore, you’ll need to save $18,000 (6 X $3,000).
The reason I encourage you to think about your goals and your values is because it’s extremely possible you’ll need to make sacrifices in order to save that much money. And sacrificing for the sake of making sacrifices isn’t compelling enough to do it. Instead, link any sacrifices to your most important financial goals and objectives. That will make difficult changes less difficult.
If you’d like to get your emergency complete in 12 months, you’ll need to be saving $1,500 a month. To do it in 24 months, you’ll need to save $750 a month. And to do it in 36 months, you’ll need to save $500 a month.
This is worth doing. It will be hard, but you can do hard things.
Cash versus credit
Resist the impulse to rely on credit cards as your emergency fund. The harsh reality of poor economic times is that banks often reduce credit limits. If you’ve currently got a credit limit of $10,000, and the bank slashes it to $2,000, you’d be in big trouble if that was your emergency fund.
Your emergency fund must be cash on hand.
Also, resist the impulse to invest the money. I know there’s an opportunity cost, but I don’t care. The last thing I want is for you to need the money, only to have it reduced due to market fluctuations.
To stay on top of your cash on hand, you need to review your cash flow and budget every month. Once you’re in the habit of doing it, and you’ve got your emergency fund set up, you can switch to quarterly reviews.
This is worth doing. It will be hard, but you can do hard things. You’re someone who can become financially successful.
If you’re ready to take control of your financial life, check out our DIY Financial Plan course.
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