The Emergency Fund

Before you dive into cash-in and cash-out strategies, it is important to build a reservoir of cash in your bucket for emergencies. Every financial planner and advisor advocates that families save cash in a “rainy day” or emergency fund to cover expenses in the event that you experience a loss in income or an increase in liabilities not originally accounted for. Uncontrollable circumstances, such as a car accident or an economic recession, can have a big impact on your budget. This is no different in the world of business and why many executives keep an eye on liquidity.

While the urge to pay off your student loans as quickly as possible may influence you to drain your savings account, not having immediate access to cash could be more detrimental to your financial future (see Case Study 1).

Case Study 1:

John is a 27yo RPh for a retail chain. As a salaried employee for this particular chain, John is paid on a monthly basis. John’s disposable income is $4,500/month and his discretionary income is $1,500/month. To be safe, John likes to keep $1,000 in savings at all times. His student loan payments are $500/month but John decides he wants to pay them off faster, so he starts using half of his discretionary income for student loans. He also wants to start building up his net worth so he decides to put the rest of his discretionary income each month into a diversified investment portfolio of company stocks. On the way to work, John loses control of his car after hitting a slick spot on the road and hits the median. John escapes with a broken arm and some bruises, but his car needs extensive repair. His car insurance and health insurance covers most of the costs, but John is required to pay nearly $3,000 in deductibles and copayments.

In our case study, John is aggressively trying to pay down his student loans, which is commendable. He is also investing in the stock market to build up his equity. Paying down debt and investing in stocks are both important steps toward financial success; however, John’s lack of cash puts him in a bind after the car accident. In order to pay insurance deductibles piggy bankand copayments, John will not only have to drain his savings account completely but may also have to sell some of the stocks he has recently purchased for cash. If the stock market took a dip before the car accident, John may even take a loss when selling prematurely in addition to all of the transaction fees of buying and selling stocks. John may be able to take out a short term loan with a bank or use a cash advance option with a credit card, but these options may have substantial fees or interest payments as well to consider. While in this cash strapped situation, John still has basic living expenses and other bills that will come due. Failure to pay bills and liabilities can destroy your credit rating and make future financing much more expensive (that is if and when companies finally loan you money again).

 Emergency Fund 2.0

The idea of an emergency fund really just comes down to liquidity. Businesses and individuals should always have access to a sufficient amount of cash to cover planned and unplanned expenses. Many personal finance advisors recommend anywhere from three to six months of budgeted expenses available in cash. While this is a good place to start, taking your emergency fund to the next level (Emergency Fund 2.0) could really stabilize your financial foundation. Next consider the costs of deductibles and “out of pocket maximums” on all of your insurance products (health, auto, home, etc.) and make sure your Emergency Fund 2.0 will cover these amounts in addition to your basic living expenses. Something as simple as an injury in a car accident could cost you quite a bit of cash depending on your insurance plan.

Once enough cash is saved to cover catastrophic events, you can start building for beyond six months. Money saved to cover expenses beyond three to six months does not have to be as liquid as the money in your emergency fund. For example, most people keep a basic emergency fund in a savings account that can be accessed with a few online clicks or quick trip to the bank. The next level of savings could be invested in money market accounts or bonds that could be converted to cash with a few extra steps. This could allow you to earn a little more interest and growth opportunity than a simple savings account. After recovering from the emergency, you can start to adjust your budget based on anticipated income and expenses then decide if you need to covert other assets to cash.

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Joey Mattingly, PharmD, MBA is an assistant professor at the University of Maryland School of Pharmacy located in Baltimore, Maryland. Joey has managed retail and long-term care pharmacy operations in Kentucky, Illinois and Indiana. Leading Over The Counter is a blog of Joey's views and opinions on the topics of pharmacy leadership and management and do not represent the University of Maryland, Baltimore. Joey can be followed on Twitter @joeymattingly.

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