What is Financial Cushion: And How Much You Need?

Financial literacy lessons

Living paycheck to paycheck is a source of added stress because it leaves us vulnerable to the unexpected. Circumstances can arise at any time. Yevgeniy Marchenko will tell you how to form a reserve fund and what tools are available for doing that.

Investor with 20 years of experience, financial advisor, founder of the company “EM FINANCE”, author of the online course “Competent Investments”, founder of the “School of Financial Advisors

What is an airbag?

Financial safety cushion is a certain amount of money that a person will spend in case he loses his job or has any problems: in business, health, household emergencies. Don’t wait, it’s better to start building up an emergency fund now. The amount of a financial safety cushion varies:

  • for a single person – three monthly expenses;
  • for a family – a minimum of six months’ expenditure for the whole family, or preferably more;
  • couples with children – preferably a reserve of 12 months’ expenses.
  • When building a safety cushion, it is important to consider all expenses you are accustomed to: utility bills, internet, communications, clothes, shoes, credit payments and food. 

Calculating your safety cushion properly

You should set aside a certain amount of money regularly to build up a good safety cushion. You should allocate 10% of your income to a safety cushion. If you use cards, it’s easy to do as many banks provide an automatic debit service. The option can be set up through mobile apps.

If you can, you can set aside more than 10% – up to 30% per month from each paycheck. Wealthy people are advised to set aside a reserve for up to 5 years or more.

Saving wisely

The main condition for saving properly is integrity! We can’t spend this money on various expensive “wants”, momentary desires (we saw something on sale and decided to buy it), or regular expenses. Even if we promise ourselves that we will return the money to the fund tomorrow. No one usually does.

Analyse your expenses, recording every penny. See what you can save on painlessly. Give up 1-2 items of expenditure, and save money as if you were continuing with your usual lifestyle. 

One last thing. Self-discipline is very important here. Determine for yourself the percentage and timing of the accumulation – and stick strictly to the chosen vector. The time frame is best set at 3 years. This is the most comfortable time frame.

Money storage options

Since a financial cushion is 100% liquid, it should be available almost instantly.

That’s why it’s best to keep it;

– in savings accounts where there is interest on the balance;

– partially withdrawable deposits;

– short bonds.

The main condition is 100% liquidity. In rare cases, when the financial cushion is of a decent size, it is permissible to keep half of the reserve funds in savings accounts and the other half in bonds. You can buy short-term bonds, where 1/3 is annual maturity, 1/3 is two-year maturity and 1/3 is three-year maturity. It is forbidden to invest in high-risk assets – stocks, funds and others.