Short Term Savings

Everyone needs some short-term savings. In fact most people need a big pot of it, stashed somewhere safe and easily accessible. By “short-term savings,” we mean the money you’ll need for emergencies and for big expenses you’ll incur over the next three to seven years, depending on your tolerance for risk, volatility, and a market-induced change of plans.

In this short-term savings area of Golden Goose, we’ll talk about places to put the money you need at-the-ready — checking accounts, saving accounts, money market accounts, certificates of deposit, money market funds, and short-term bonds — and the pros and cons of each investment. We’ll help you figure out how much you may need and the circumstances under which each type of investment may be right for some portion of your more liquid assets.

When we say “liquid assets,” we’re not talking about Oil and Evian water stock. Think of “liquidity” as the ability to be quickly and easily poured from one vessel to another with little loss. Cash is the ultimate in liquidity. It’s welcome everywhere, there are no costs associated with using it, and it’s always worth exactly what you think it’s worth. By contrast, real estate is not very liquid. It takes a long time to convert it into a readily transferable form, and you tend to “spill” quite a bit — a whole bucket load of commissions and closing costs. In between cash and real estate is a range of investments, with varying levels of liquidity.

What could happen if you don’t have short-term savings? One of two very unfortunate things:
1. Emergencies or even should-have-been-foreseen expenses will spring a credit card trap on you that can take years to escape from.
2. To cover a sudden (or not-so-sudden) expense, you may have to sell assets, such as stocks, that were intended to cover long-term goals. Consider this all-too-likely scenario: You put all your spare money in the stock market and suddenly you need $2,000 for car repairs. Unfortunately, this happens during a time when the market is down, and you have to sell your stocks at a loss. Plus, that money is no longer invested, so you will miss out on future growth.
Though your short-term savings will never rival returns on stocks over the long term, we certainly think that short-term money needs to earn its keep, countering inflation and maybe earning a little more. You’ve got several options on where to keep your short-term stash. But first you need to do a bit of financial self-reflection to determine how much short-term savings you need and when you’ll need it.
How much should I have in Short Term Savings?
The amount you squirrel away in safe, liquid investments is ultimately a personal decision, however, we certainly can provide some guidelines. How much you set aside depends on the following factors:
1. Your willingness to take risk.
Some folks are comfortable with five years’ worth of planned, major expenses in a safe, stable account. Others are more conservative, taking a seven-year view. Risk-tolerant investors may have more faith in the stock market, keeping just three years’ worth of big-ticket expenses in a short-term savings account and putting the rest in stocks. How much volatility can you withstand? How will you react if you’re 63 years old and your RRSP drops 30% (as many did over the past year)? How confident are you in your equity investments? Your answers to these types of questions will help you determine the amount you should have in short-term savings.
2. Your needs.
Three to six months’ of living expenses set aside for emergencies should be a given. This will cover your expenses in the case of temporary unemployment or disability. (When it comes to disability, it’s just as important to have enough insurance.) Also consider big-ticket bills coming up, such as the auto insurance bill, and a maintenance slush fund to cover an exploding engine or flooded family room. These funds should be safe and easily accessible.
A final consideration is your number of dependents. If you’re responsible for just you and your pet, then you can be a little looser with the emergency fund. However, if you’re responsible for a family, then you should shoot for six months’ worth of expenses, at the very least. The more people directly involved in your financial well-being, the greater chance you’ll encounter unanticipated expenses.
3. Your upcoming expenses.
Think of the expenses you must pay for from savings (not wages) over the next few years. Have you set aside money for that trip to Tuscany you are planning to take in two years? How about the down payment for that new car or house? Will you need tuition for the child(ren)’s education? Are you getting married and paying for the honeymoon and/or the wedding reception?