Investing Tip:

Cash Reserve

A couple of weeks ago I did a tip about debt. Well in a conversation I had with someone recently I was reminded that I don't often talk about the next step. Many people approach me and say "I've paid off my credit cards and now I'm ready to invest". They want to know if stocks, bonds, mutual funds or real estate, etc., etc., is the place for them to start. The answer is none of the above. The first thing everyone should do is establish an emergency cash reserve.

It's really the answer to the debt question. People usually go in to debt because they have a big car repair bill come up, or a surprise IRS tax bill, or one of any number of unforeseen problems. But the way to deal with it is not to borrow. It's to save in advance and have a cash reserve on hand for those emergencies. Yes, you're not going to make much money on that cash (though money market rates are rising rapidly). But everyone should be able to immediately put their hands on a liquid reserve of cash when needed.

How big a reserve? You hear things like three months income, six months income, etc. The answer is that it depends on your situation and your job. If you're a single US Postal worker, you're not likely to lose your job soon and you have no dependents, maybe $5,000 is enough. If on the other hand you work in aerospace with their frequent layoffs and have four kids, you probably should have six months income on hand.

It's a disappointment for many people. They finally have a few thousand dollars they've saved, and they want it to work hard. But what would happen if in 3 months the roof starts to leak? They'll have to sell their investments (very possibly at a loss) to patch the roof. Having your investments depend on your roof is not a great idea.

So if you haven't done so, build up a cash reserve. And when it's there you will experience an amazing thing. You'll sleep much better.

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Donald Steinmann and Advanced Financial Management assume no responsibility for any actions taken due to comments made in The Investment Tip of The Week.