Financial Planning

How-To Guide: Create a Cash Cushion

Effective money management is more important than ever in these troubled economic times. Through our partnership with The Motley Fool, we are able to provide you with great personal finance articles that can help you jumpstart your financial planning and give you the actionable advice you need to address the financial crisis.

Emergencies happen. You might as well plan for them. Whether it’s a temporary job loss or an unexpectedly high orthodontist bill, having some cash on hand will cushion the financial blow.

Creating a cash cushion for planned expenses is a good idea, too. So to help you on the path toward financial stability, follow this four-step plan, and start saving!

1. Consider your risk and responsibility.

Do you have extra mouths to feed or preschool tuitions to pay? Is your job stable, or is your industry going through a hiring lull? Your answers will help determine how thick your cash cushion needs to be.

2. Figure out your essential expenses.

You’ve probably heard that you should have three to six months of expenses set aside for an emergency. That rule of thumb is a good starting point for your calculations, but you might need less than that — or more. It’ll take just 10 minutes to come up with your exact emergency savings amount.

3. Calculate your short-term cash needs.

Your cash cushion also includes money you’ll need for expenses coming up in the next three, five, or seven years, depending on your risk tolerance. (You don’t want this money in the stock market. Trust us. Stock investments are too volatile to risk your short-term cash.)

4. Get the best return on your emergency savings.

Mingling your emergency and short-term savings with your checking account puts your savings at risk. Instead, keep this money separate — and get a better return on your cash while you’re at it. Taking into account liquidity, interest rates, risk, and account costs — so you can find the best return for your bucks.