Create a Savings Target
Your savings balances may fluctuate a lot during the year depending on stock vesting, property or income tax payments, and many other things. But your Savings Target should not fluctuate.
Your Savings Target is made up of two things:
- Your Emergency Savings
- Your Net Cash Needs over the next 5 years
An Emergency Savings is the amount of money needed to pay your expenses should an emergency occur. For most people this is a job loss. But to get the right amount, we must consider a realistic scenario where you might lose your job. Likely it’s when the entire economy is down and perhaps your industry is also not doing so well.
In that circumstance how long, realistically, do you think it would take you to find another job? You need enough money set aside to pay your Living Expenses while you look for that job and that’s your Emergency Savings.
Net Cash Needs
You also need to hold net cash needs over the next 5 years, along with your Emergency Savings. In other words, project your income and expenses including any extra expenses like a home remodel, special vacations, etc. over the next 5 years. You’ll want to hold enough cash to meet these needs because they won’t be met out of your future income.
Putting these two together gets you your Savings Target.