Reserve

This article is a continuation of previous posts on the review of a book called Achieve Financial Freedom by Sandy and Matthew Botkin. Check out the previous post as below:

16 reason people fail financially

Sandy continues the book by telling his interview with a banker, Sam to talk about reserves. First of all, Sam had defined what is reserve and why reserves are absolutely necessary for everyone who is earning.

"A reserve is a risk-free and penalty-free fund of money that will be immediately available for use upon the occurrence of a major expense or a big unanticipated expense."

People need them for unanticipated expenses such as repairs, for 12 months of living expenses in case of a job loss (assuming a not-so-stable job), and for upcoming big expenses such as weddings or college costs, that are expected to be incurred within 3 years.

Next, they talk about how much reserve everybody should have.
Factors for computing needed reserve are based on the following:

1. Income stability. Chances of losing a job for someone who has a stable job (such as government job) are much slimmer than those who do not have a stable job. Generally, those with stable jobs may only require 2 times their monthly income. The rest will require 12 times.
2. Living expenses. The greater your monthly living expenses, the greater the reserves you need. Tracking 3 months' worth of living expenses is needed to pick up the average.
3. Unexpected expenses. Repairs for the house, cars, or medical expenses especially those which are not covered in any medical insurance.
4. Big anticipated expenses occurring within 3 years like child college, wedding or braces for kids.

The following formula summarizes the above:

1. 12 months of living expenses, plus
2. $5000 - $10000 for unanticipated expenses (might considered high, but personally I think it all depend on the assets or property you owned), plus
3. Large expenses to be incurred within 3 years, plus
4. If you start up a business, 2 years' worth of business and personal overhead expenses.
   Single people might need to add up their reserve since they are totally dependant on their own income.

Now we are looking at where should reserve money be placed. Mistakes people often made is that they thought retirement fund or insurance cash value is considered reserve, the same goes for keeping property or investment in the stock market. Reserves should be placed in safe, liquid accounts that do not have any withdrawal penalties or risk of losing money like a good old savings account or a shorter tenure fixed deposit. The idea of keeping a reserve is that the investment return is irrelevant.

Finally, how do we save money for reserve? Sam pointed out that most of us should have a fixed amount taken out each paycheck for the reserve funds and learn to live on the rest. 10-15% or even more of your paycheck is recommended. However, if due to other commitment we can't seem to meet the obligations of taking out that much, 5% will suffice.