A cash buffer is your first line of defence against expensive debt, unnecessary stress and being overwhelmed by life’s unexpected events. Yet too many of us fail to build a cash reserve that we can fall back on if we become unwell, need an urgent repair, or face unemployment. This short article helps you work out what you need.
First things first: actual cash is no longer easy to spend
A few weeks ago I was paid in cash for some second-hand goods. I kept one crisp note as a souvenir (it was colourful and novel), and decided to bank the rest. Since so many shops have gone ‘cashless’ it’s easier to have the money in the account to access electronically. To my surprise, my bank has a limit of how much cash I can deposit each year – and I was over that limit. The threshold was pretty low (£1,000) – and allows the bank to avoid most grass roots money laundering. But still, I was surprised.
So, when I talk about a ‘cash buffer’ it isn’t really cash at all. It’s money that you can access – and use – easily.
Why do you need a cash buffer?
Recently Deloitte published their annual survey of Gen Zs and Millennials which covered over 14,000 people in 46 countries . They highlighted that 46% of Gen Zs and 47% of Millennials live pay check to pay check. That’s almost half of the population aged between 20 and 40 who worry that an unexpected expense will send them into debt or into arrears in their payments.
There is no doubt that cost of living, income inequality, social instability and other factors contribute to this pattern of living pay check to pay check. However, there may be ways that you can build up a cash buffer, so that you do not have to rely on expensive debt – like credit cards – to pay for unexpected costs.
You basically need a cash buffer so that you do not have to rely on expensive, and sometimes dangerous, forms of debt or borrowing. You may prefer to call your cash buffer ‘Freedom Money’ or ‘Running Away Money’. Whatever you call it, understand that having a cash buffer is your first step to having financial flexibility and independence. If you have other assets, but no cash buffer, it could put a severe strain on your mental health, if suddenly you need to sell some assets (e.g. stocks, or even a residence) to cover your costs. It’s not pretty, believe me – I have experienced a cash crunch, and it was horrible.
What’s a cash buffer for?
You may feel that your most immediate risk is losing your job. If that is so, how long do you think you will be out of work? Three months? Six? Your cash buffer may help you move home so you can cut costs, or find different work – as well as covering you when you have no income.
However, there may be an unexpected cost which comes up – like a car repair or replacement – which is expensive and essential for you to work. A cash buffer can help with this (so can insurance, but that is not the focus of this article).
How much cash do you really need?
This is so hard, and truly the only person who can answer that question is you. But these are my steps for working out what you need:
- Look at your monthly spending (NB not your income);
- See where you may be able to trim some expenses;
- Then imagine your most likely risk – an expensive car repair, or loss of job – and try to work out how much it will actually cost you. It could be three months of expenses, or the cost of another vehicle (and registration, taxes, etc);
- Add in some sort of buffer so that you feel comfortable with this amount;
- Modify and adjust (adjust down to make it achievable, adjust up to feel more secure). Revisit this amount when your life circumstances change.
The sweet spot is smaller than you think
My mistake was thinking that I needed 12 months of income as a cash buffer – because, hell, that’s what I had been told. It was such an astronomical amount of money to consider (before tax too!) that I just couldn’t get started on saving. I didn’t see the point, since it would take me at least 25 years at my current saving rate to even get there. Never mind inflation. It was 100% a mental block. The number was too big, so I just couldn’t.
Don’t let this be you. If three months of expenses seems too much to try to save up – start small. Start with a week of expenses and build from there. A week of breathing room is better than no breathing room at all. You can do it by putting something aside today.
How much do you need? Is it all too complicated to consider alone? If you want help with decisions like this, I offer a free 30-minute introductory session to money coaching.
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