Why build a financial reserve and how high it should be

(This article is NOT financial advice).

Investing is important in life, but equally investors and ordinary people should take care to have sufficient funds in case everything does not go exactly as planned.

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Why have a financial reserve

Even the best planning of personal finances can not be done without reserve. One never knows when he will get an unexpected layoff at work, his car will break down, or he will have to pay for his children's health care. These life situations are already challenging in themselves, and if there is still a lack of money in them, can get into serious complications.

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Investors will appreciate the financial reserve (that is, free cash) even if a great investment opportunity suddenly arises. If the investor does not have free funds at the moment, the profitable investment could be irretrievably missed.

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Financial cushion in case of short-term complications would therefore All adults should have formed, regardless of whether they are employed, in business or how old they are.

It's not just about having cash available in case of trouble. The reserve also functions as prevention and protection against disadvantageous lending of money. During turbulent times, people do not have to go into debt and risk getting into even more financial trouble.

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Even the best planning of personal finances can not be done without reserve.

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The reserve should cover expenses for at least 3 months

So the key question is: how much money to put away for a worse time? As is the case with finance, there is no universal answer to this question. It always matters amount and stability of income, commitments (mortgage and other debts), the amount of regular expenses Whether a person goes to work for a long time with a stable salary or runs a business — the pool of entrepreneurs should always be significantly higher.

However, it is generally recommended to have an amount that completely cover the necessary expenses for 3-6 months. Of course, everyone has them differently high, so we will use a simple model example to illustrate.

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Example: 4-month reserve of marketing specialist Petra‍

Marketing specialist Petra (26 years old) lives alone in rent and has a regular monthly income from her job. She hasn't taken out a mortgage yet and doesn't owe anyone money, so her expenses aren't that big. Petra pays CZK 14,000 every month rent and energy, approximately 5 000 CZK spends on food. In addition, he needs at least 4 000 CZK per month for petrol. Other Necessary Costs (flat rate with mobile operator, clothes, necessary household necessities and more) amounts to about 5,000 CZK. Thus Petra's fixed monthly expenses are 28,000 CZK. These are only necessary costs, necessary for normal functioning in everyday life. They do not include a budget for entertainment, culture or money to invest. Petra wants to have a reserve for at least 4 months, so she should save 112,000 CZK.

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How to work towards a comfortable financial cushion

The most important thing is not to wait for anything and start put aside money for worse times as soon as it goes and long term. The faster the reserve is built up, the better — reducing the risk that the reserve will be insufficient if necessary.

If the situation allows, an ordinary person should set aside monthly in reserve 7-10% of the payout, or from other income. But as with investing, regularity is key. Therefore, it makes sense to save even a smaller amount per month, but just as high and with iron regularity.

Less can be saved by those who already have some reserve and need to increase it in order to have money sideways for the recommended 3-6 months.

In any case, the inquiry into worse times is not just about deferring income, but also Partial Reduction of Expenditure. If you manage to save a few hundred kronor each month on seats in a cafe, buy leftover things and the like, in half a year the difference in total savings can be huge.

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If the saver suspects that higher one-off expenses await him in the foreseeable future (e.g. a wedding, buying equipment for a newborn or buying a new car), he or she is more confident to increase the financial cushion by these items.

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A number of people in creating a financial cushion also helps to write down residual and necessary expenses and see if they manage to put more money into reserve than before.

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With the necessary reserve in a savings account, the rest is better to invest

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In addition to regular savings, the place of depositing a financial cushion also plays a role. The necessary short-term reserve — that is, the amount corresponding to expenses for a period of 3-6 months — is ideally placed in a savings account at the bank. Thanks to this, it can be used at any time and immediately, in addition Savings accounts will at least partially pay interest on this money.. This is a better solution than leaving the entire reserve in the current account, where the finances are completely eaten up by inflation.

But savings accounts should really work just for basic reserve. Any unused money beyond its scope makes sense to invest.

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Any unused money beyond the financial cushion makes sense to invest.

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Did you know that 29% of Czechs do not have a financial reserve for even a month of life? This was the result of a survey conducted in December 2022 by Česká spořitelna in cooperation with the Institute of Sociology of the CAS and the data portal Evropa v data. This confirmed once again how crucial it is to create a financial cushion and invest.

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“Excess” money appreciates nicely in fixed income investments

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Leaving hundreds of thousands to millions of crowns in a savings account for a long time is not a good idea. Although this method of storing money is virtually risk-free, it brings only a minimum appreciation that does not cover inflation.

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The ideal is to invest excess finances, for example, into fixed income assetswhich is also offered by Investown. These always have a predetermined interest rate (their yield is stable), are less risky and fit into the portfolio even for investors who prefer lower risk. Alternatives can be stocks and ETFs (high risk), precious metals or physical real estate.

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This article is not financial or investment advice

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Investown does not provide financial and investment advice. This is an educational article with basic information about the financial reserve. For specific advice, we recommend using the services of a financial or investment advisor.