Reserves in Savings

It may take awhile before all that high interest debt has been paid off and you’re back to a positive net cash flow each month. Once you do achieve that, what’s next?

Savings in Reserves

Since you now have a budget and you’re tracking your income and expenses, you are in better shape then most. You’re not guessing anymore. You have your fingers on the pulse of your financial life. Awesome. You should be proud, but let’s move on to the next step. Savings in reserves.

A good rule of thumb is 3 months. I’ve seen this range from 2 to 6 months. Personally I think 2 months is a little short and 6 months may be difficult. We can always add more to savings, but let’s target 3 months.

Go back through your budget now that all the high interest debt is finally gone and you’ve adopted the discipline to prevent it from occurring again. Evaluate that positive net cash flow you have. We already have a goal for the amount of money we want in reserve. Given we know the positive net cash flow and we know the total for all monthly expenses, we can set a goal to getting that 3 months of reserves.

Prioritize

You should be comfortable now with prioritizing your spending habits. A savings reserve is another priority we need to address now. First, you can add up 3 months of all expenses and divide that by the positive net value in your budget. This is the most aggressive. Given this savings is a priority, then again we want to zero out our net until we can achieve this goal. As an example, if your monthly expenses are 2k per month your savings goal is $6000.00 (2K x 3). If your positive net income per month is $250.00, then you can achieve this goal in 24 months. (6000/250)

Moving Target

We saw above where we can meet our goal in 24 months. However, prices tend to go up (utilities, streaming services, insurance, etc.) so this can become a moving target. Hopefully you will also be getting a raise at work, maybe a yearly bonus or take on a side hustle. This is exactly why we have our budget. A budget is no good if we don’t learn from it and use it. Tracking expenses monthly shows us what is going up and by how much. Our monthly net is a constant gauge that shows us how we’re doing.

Final Thoughts

Above is ‘assuming’ that your monthly budget already contains an entry for retirement savings. This really is a must. If you don’t yet have a retirement savings plan, then I would suggest you modify above. It will take you longer to achieve your reserve savings goal, but you will be starting that retirement savings plan. For example, if your positive monthly net is $250 and you have no retirement savings, you could put $125 into a retirement savings account and the other $125 into a savings account. It will double the time to build up your reserves, but again, at least your building your retirement savings. Remember there are steep penalty fees if you withdraw from a retirement account before the plan allows it.