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:
The following formula summarizes the above:
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.