The New Year is upon us. How can you tell? Drive by the parking lot of any gym and notice the scarcity of available spots. It’s resolution season!
Fortunately this is not another article about why you should get off the couch and onto a treadmill. In fact, go ahead and grab that last potato chip (you’re welcome!). Truth be told, this article is about fitness – just not the physical variety. Instead, the topic is financial fitness. And as it turns out, pushing piles of cash doesn’t require nearly as much effort as moving off the couch!
Financial fitness starts with a basic, but vital, account called a reserve fund. That’s our focus today.
A reserve fund is simply money set aside for unexpected events, such as the loss of a job, medical emergencies, unexpected home repairs, car troubles, and other financial shocks. The sole goal of the fund is to protect your financial wellbeing by providing a security blanket when life throws you a cold shoulder.
Let’s look at the power of a reserve fund in action.
Imagine you go home this evening and discover your 16-year-old furnace has exhaled its last (hot) breath. There’s no other option – you have to replace it. But a furnace and installation can cost upwards of $2,500. What if you don’t have that kind of money lying around?
It might be possible to charge a credit card. While that may be an option, it adds to your debt load and likely means you will be paying sky-high interest rates until you pay it off. Another possibility may be draining money from a retirement account, such as an IRA or 401(k). Unfortunately, that type of withdrawal could cost you years of extra work and savings to make up for the lost growth in your account. So while there are potential solutions, they come with steep prices.
If, on the other hand you had a reserve fund, you could simply “lend” the necessary funds for the furnace to yourself at an attractive 0% rate and on a repayment schedule determined by you – although replenishing the reserve fund should be a priority.
Identifying an ideal amount for a reserve fund depends on your personal situation. As a rule of thumb, plan on stashing enough cash to cover your essential living expenses for six months.
The good news is you don’t have to come up with this money all at once. You can grow into your reserve fund over time. The most important step is simply starting, even if your initial savings amounts are small.
Like a warm-up before exercise, a reserve fund is intended to prepare you for the demanding activities to come. You can’t be fit – financially, that is – without it.
Now get off the couch and find that last remaining parking spot at the gym! You have some potato chips to burn! Happy New Year!