What to save for rainy days

3 months in living expenses is goal for most people

December 09, 2007|By Harriet Johnson Brackey | Harriet Johnson Brackey,South Florida Sun-Sentinel

The personal financial picture doesn't seem too bright these days.

The stock market, with all of its uncertainty over credit problems, remains shaky. People know how bad housing is. The economy is slowing down.

In times of uncertainty like this, investors should consider hunkering down and spending some time going over the basics. They want to feel secure, while waiting for housing to recover, watching the economy wind down and seeing the stock market do whatever it will do.

The first basic is an emergency fund, with some cash, readily available.

Cash is an asset, like stocks and bonds and real estate.

The question is, how much should you keep in cash?

The answer depends on your age and circumstances.

Harold Evensky and Deena Katz, two of the financial planning industry's superstars, came up with a strategy during the 1980s that is supposed to allow their retired clients to have sufficient cash without ever being forced to sell stock in a down market. Evensky and Katz, based in Coral Gables, Fla., wrote about their strategy in a 2006 book, Retirement Income Redesigned.

"Rules of thumb are always dangerous," Evensky said. "No one can keep enough in cash to weather any kind of a storm.

"But what you want is some breathing space, enough to make plans for what you're going to do as an encore if everything went to hell in a handbasket."

Evensky knows that nobody is going to put a year's worth of living expenses away, just in case one day they might lose a job.

He said that if your job is secure, if you have enough insurance coverage to make it through a period of disability, you probably don't need to set a large amount aside.

For most working people, he suggests three months in basic living expenses, enough to cover the mortgage, groceries and insurance premiums. And note that he doesn't say three months' pay, which is probably higher than the bills you absolutely have to cover.

The question of how much cash to have available is perhaps even more important to someone who is retired.

Evensky's cash strategy for retirees begins with a realistic estimate of how much cash the retiree needs to live on. Many retirees find they spend more, not less, than during their working years.

He recommends that retirees put two years in living expenses into a money-market account. He also invests three years in living expenses in short-term bonds.

The rest of retirees' money is put into a long-term portfolio of stocks, bonds and other investments.

The money-market account is what the retiree uses for daily living expenses. It can be set up to send the retiree a check every month, like a paycheck. Periodically, when the investment portfolio is doing well, Evensky recommends selling some winners and using the proceeds to replenish the money-market account. He also suggests putting any dividends or other income into that account.

What happens when stock markets are not doing well? The retiree should sell the short-term bonds, which tend to hold their value when stocks are declining.

The point is to protect the long-term portfolio and not to sell stocks when they are down. And that is important because stocks, over the long haul, tend to go up more often than down. Big stock market drops have been followed by gains - eventually. And the growth potential of stocks is what will keep many retirees afloat as they live longer and spend more money than perhaps they had planned.

It worked during the 2000-2002 bear market. Evensky did not have to dip into anyone's portfolio during that bad period for the market.

There's a neat little side benefit, too. When all your money isn't in the market, it might make it easier to withstand the dips, knowing you still can pay the bills.

Harriet Johnson Brackey writes for the South Florida Sun-Sentinel.

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