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Hopefully in a prior post, I have convinced you of the absolute necessity of having adequate reserves. The next question is how much should they be? There are three criteria used in figuring out the need for reserves:
1. Living expenses: Most planners suggest at least 12 months of living expenses. However, this assumes that you and your spouse have unstable jobs that can be prone to unemployment. If you have very stable jobs, such as government jobs, you might need only 3-6 months of expenses. Likewise, if you are a single parent with tenuous job stability, you might need as much as 24 months of expenses. For most people, 12 months of expenses should be the goal.
2.Unanticipated expenses: These are big, possible, future expenses that can crop up at any time. They can be for big car repairs, house repairs, sudden medical and dental expenses, etc. I suggest at least $5,000 and preferably $10,000 for these possible upcoming calamities.
3. Big Anticipated expenses occurring within three years: In addition to the above, a savings account for the upcoming big expenses is mandatory. Examples of this would be college tuition and wedding costs and braces.
4. If you are going to start a business while not working, at least two years of living expenses and business overhead is essential. The sum of all these will equal your reserve requirement
Example: Assume that you have $5,000 a month in living expenses plus are expected to pay $30,000 for an upcoming wedding in less than two years Your reserve requirements are as follows:
1. Monthly expenses x 12= $60,000
2. Reserve for unanticipated expenses 5,000
3.Upcoming big anticipated expenses ( wedding) 30,000
So here is the formula:
1. 12 months of living expenses, plus
2. $5,000-$10,000 for unanticipated big expenses, plus
3. Large expenses expected to be incurred within the next three years.
The next post will show where funds for reserves should be invested.