Do You Have Extra Cash? Here’s How You Can Tell and What to Do with It
Categorizing your available funds and having a plan for your money is crucial to financial independence and long-term success. If you’ve read my posts before, you know I’m firmly against having money just sitting around without a goal or purpose. This leads me to today’s topic, extra cash, and more importantly, what counts as extra cash and what you should do with it.
What Doesn’t Count as Extra Cash
First, let’s talk about what doesn’t count as extra cash. You might have a savings account with $20,000 in it sitting around collecting a little bit of interest. Is that extra cash? Well, if you’re planning to use it in the next 5 years, it isn’t extra cash.
The money is already spoken for, and the last thing you want to do is invest it and find yourself dependent on the market to help finance your planned spending. But how far forward should we project spending and then hold cash for those purchases?
I like to project 5-year cash inflow and outflow to determine the amount to have set aside.
Simply look at your cash income for the next 5 years and your cash outflow for the next 5 years, offset those two and if you have negative cash years, that’s the amount to set aside.
This money should be held in an accessible, safe place like a high-interest savings account. It won’t earn a ton of interest, but you won’t see it disappear if the market tanks either.
The job of this money is to actually be there when you plan on spending it.
Let’s Talk Emergency Funds
Aside from cash you plan to use, you need to keep an emergency fund as well.
For most people a financial emergency is losing your job, so let’s consider how long it would take you to find your next position. But let’s make this realistic and consider what the job market would be like in the type of environment where you are let go from your current position.
This is far different from asking how long it would take you to find a job today. Instead, we want to know how long it would take in a very bad economic and job market scenario for your particular specialty.
Most people land on 6 months or more. Whatever the case, let’s take your living expenses for this period and that gives us our Emergency Fund. Add this to the net cash needs we calculated above and we have our Savings Target.
Now that we’ve covered these two areas, we can get into extra cash.
What Do You Do with Extra Cash?
Extra cash is anything you have left over. Once you have your 5-year cash flow projected and set aside along with an emergencies and planned expenses, we get into the fun part. Whatever is left and just sitting around should be in your long-term portfolio. Investing this well for the long run will help fund your eventual retirement and financial independence.
Despite what the “gurus” might tell you, there’s nothing wrong with having cash sitting in a savings account or short-term cash vehicle like a CD. Not everything needs to be in an investment portfolio. However, we need to be realistic in estimating our cash needs so that every dollar is doing the job it needs to do for us to build our Best Financial Life.