Liquidity Needs: Why It’s Important to Have Cash on Hand
As we go through life, our financial needs change. We may start out with student loans and entry-level jobs, but eventually, we’ll need to think about bigger expenses like buying a house or starting a family. One thing that remains constant throughout all of these stages is the importance of having cash on hand.
What Are Liquidity Needs?
Liquidity needs refer to the amount of money you need to have accessible at any given time to cover your expenses. This includes everything from day-to-day living expenses like groceries and rent/mortgage payments, to unexpected emergencies like home repairs or medical bills.
Most people think of their liquidity needs in terms of an emergency fund. An emergency fund typically consists of three to six months’ worth of living expenses saved up in a separate bank account. This money should only be used in case of an emergency – something that would cause significant financial hardship if not covered.
But beyond just having an emergency fund, there are other reasons why it’s important to have cash on hand.
Why Is Liquidity Important?
1) Flexibility
Having cash on hand gives you flexibility in your finances. It allows you to make purchases or investments without worrying about how long it will take for funds to become available or whether you’ll be able to access them at all. For example, if you see a great deal on a used car but don’t have the full amount saved up yet, having some cash available can help you make the purchase and avoid missing out.
2) Security
Cash provides security when unexpected events occur such as job loss or illness that could affect your income flow for several months. In such cases, having savings from previous earnings can keep you going until things improve again.
3) Peace Of Mind
Knowing that you have enough cash reserves set aside for emergencies can give peace of mind knowing that regardless what happens financially, you can handle it without much stress.
4) Avoiding Debt
Having cash on hand is also a way to avoid getting into debt. If an unexpected expense comes up and you don’t have the money saved up, your only option may be to put it on a credit card or take out a loan. By having cash reserves available, you can avoid this situation entirely.
How Much Liquidity Do You Need?
The amount of liquidity you need will depend on several factors such as your lifestyle expenses, income flow, and risk tolerance. However, as mentioned earlier most financial experts recommend having at least three to six months’ worth of living expenses saved in an emergency fund.
But beyond that, there are other things to consider when determining how much liquidity you need:
1) Job Security
If your job is stable with no signs of layoffs or downsizing anytime soon then the recommended sum for emergency funds could be lowered slightly. But if you work in an industry where jobs are not very secure or have had previous layoffs recently then increasing the amount in savings would be more appropriate.
2) Dependents
If you’re responsible for supporting others like children or aging parents then it’s essential to keep more money available than someone who doesn’t have these responsibilities because emergencies tend to happen at unexpected times and taking care of dependents requires extra expenditures that may not have been factored into monthly budgets.
3) Health Status
People who suffer from chronic illnesses may require higher amounts set aside due to greater likelihoods of expensive treatments and medications needed at different intervals throughout their lives.
Where Should You Keep Your Liquidity?
When it comes to keeping your liquidity needs accessible there are many options available but depending on how comfortable one feels with risks, some options might be better than others:
1) Savings Accounts:
This is one of the most common places people keep their emergency funds. The funds earn interest over time which means they grow while still being readily accessible when needed. However, interest rates on savings accounts are typically very low compared to other investment options.
2) Money Market Accounts:
Money market accounts are similar to savings accounts but usually have higher interest rates and may require a minimum balance or charge fees for withdrawals. They also offer more flexibility in terms of accessing funds than some other investments like CDs (Certificates of Deposit).
3) Short-term bonds:
Short-term bonds can be another option for keeping your liquidity needs accessible. These bonds typically have a maturity of less than two years, which means you won’t have to tie up your money for too long before you can access it again if an emergency arises.
4) Certificates Of Deposit (CDs):
While CDs tend to offer higher interest rates than savings accounts and money market funds, they come with the risk of losing principal if withdrawn before the maturity date. They’re still better suited as a short term option unless one is comfortable with taking risks such as penalties on early withdrawal.
Conclusion
Liquidity needs are just as important as any other aspect of personal finance planning. Having cash reserves set aside provides security against unexpected events that could affect income flow while avoiding debt at the same time.
Knowing how much liquidity you need will depend on various factors such as lifestyle expenses, job security, health status etc., however; most financial experts recommend having at least three to six months’ worth of living expenses saved in an emergency fund.
Finally, where you decide to keep your liquidity depends largely on personal comfort levels when it comes to taking risks since different options carry varying degrees of risk vs reward trade-offs.