Speaker 0 00:00:02 <inaudible>
Speaker 1 00:00:08 What's up, everyone. Welcome to the finance for physicians podcast. I'm your host, Daniel Raimi. Join me as we dig into what it looks like for physicians to begin using their finances as a tool to live better lives. You can learn more about our
[email protected] let's, jump into today's episode. Have you ever felt like you don't have enough cash in the bank for rainy day? Maybe, you know, it's too low, but you're unsure what the ideal amount really should be. Or maybe you feel like you have too much cash, but the same thing is true. You're not sure what that ideal amount really needs to be today. We're going to be talking about how to set the ideal cash target for your rainy day fund is such a big deal. And I think is one of the most commonly overlooked areas of personal finance. I think it's become a little bit more of a priority for people, uh, since the pandemic has happened.
Speaker 1 00:00:58 I think that's caused people to think twice about, uh, uncertainty and everything, but, uh, it still seems to be an overlooked area in, in finance. So why is it such a big deal? Well, rainy days are unpredictable. And so having too little cash is going to result in, uh, unnecessary stress and potential for even worse. Uh, especially if you get into the stormy period of life. I like to think of the rainy day fund is more of like an insurance policy. It's not, it's definitely not something that is going to make you rich or wealthy. It's also on the other hand, something you don't want to have too much of either you, you never want to have too much cash because that can be expensive as well, expensive in the form of, uh, opportunity costs maybe from, uh, not having those funds otherwise invested in earning you money or paying off debt and avoiding interests.
Speaker 1 00:01:51 So ideally you're right on that target that ideal amount of cash reserves. Ideally you're not over or under, but if you are, you know, exactly what you need to get to, and by knowing this, it's going to empower you to make better decisions and ultimately reduce stress risks, and also potentially increase the return on your dollar before we get into iron. And now that number, I think it's good to hit on some of the things you might need to do before you even start building your emergency reserve or rainy day fund. So some of those things, I think the first thing would be to have like a little bit of a buffer, maybe one month of expenses, just in your checking account. I think that's a healthy kind of buffer to avoid having to transfer money back and forth all the time. That's going to keep you from having to even go into credit card debt even more, but having that one month of buffer in your checking account, I think is a good first step before you do anything.
Speaker 1 00:02:54 The second thing would be paying off prior credit card debt balances. I think it's going to be good to pay those off before you start building your emergency reserves, even if it's 0% interest rates, because that's, that's kind of, um, you know, ultimately gonna be a high rate debt. Uh, you can only play the credit card swap game for so long. And then if you have any other high rate debt, that's also, you know, especially if it's very high rate like credit card debt, some personal loans that that might be an, a priority as well before you even start on the building up for a rainy day fund. So let's say you're ready. Uh you're there you're you're um, you're ready to start building up your reserves. So how do you set the target? So I think there's definitely rules of thumb. I'm sure you've heard like, you know, saving three to six months of expenses or some people say three to six months of income, but that's actually a pretty big range when you think about it.
Speaker 1 00:03:53 It's I mean, it's double, so it's like, you know, say three months is a 30,006 months is 60,000. I mean, that's double, uh, so ideally I think it's better to personalize it to your situation and kind of hone in on where you need to be on that range. And I think the range is more like one to maybe 12 months of expenses. I think that's a better range. It can be even higher than that, but, um, for most people it's going to be one to 12 months of expenses, I think is the range. And the way that you decide where you are in that range is just start to look at the risk factors that come into play, that that are potential reasons you would have the reserves in the first place. Those are the next things we'll talk about. I wanted to just iron out some of the most common risk factors that come into play.
Speaker 1 00:04:45 So by, by looking at each of these, it'll start to help you better hone in on what your number needs to be. So what are those key risk factors? So the first one, uh, would just be like, what, what do you own that takes upkeep costs, uh, or has upkeep costs, uh, what type of stuff do you own that can cost money to, to kind of keep, uh, up to speed? So the, the classic examples are the house, a house is expensive. If you've owned a house, you'll know, uh, or maybe you have two houses or even three cars are another good example, boats, those kinds of things break and, uh, sometimes unexpectedly. And so having the more of those types of things, you have, the more types of things like that, that you own that lends itself to needing more cash reserves. The next big factor would be how large is your household.
Speaker 1 00:05:37 So let's say you're single, that's a low-risk situation on the end there and say you have seven people in your household, maybe you're married and you have five kids. So that that's a much higher risk situation. There's a lot more, um, you know, each individual has some risks there. Like there's, there's just healthcare risks, um, you know, stuff, the more people you have, the more unexpected there is. So the larger your household, the more it lends itself to having a higher need for cash reserves. Another big factor is what is your insurance deductible? Now you can change this if you need to, but let's say your insurance deductibles are really high. That translates to needing more cash reserves personally, on the other hand, if you have a very low insurance deductibles, there's just not as as much risk. Uh, there, you're not going to have to write as big of a check, like a very low number might be $50 deductible on your car.
Speaker 1 00:06:30 On the high end, you might have like a $5,000 deductible on your car. One of the other factors, this is probably one of the biggest factors is how much does your household earn and how secure are those income sources? So if we look at earnings, I think it's, you want to look at, um, how close you are to capacity. So what I mean by that is if you had to, within reason, could you increase your earnings quickly? So let's say that your like me, my spouse stays at home, takes care of our children, but if we had to, if we got an, a pinch, she could go back to work so that that's added capacity. So we're not at our full capacity. Another example, let's say you work part-time that's, um, you know, you, if you had to, you could bump up to full-time. So that's, that's added capacity.
Speaker 1 00:07:23 The closer you are to full capacity, the more risk there is in kind of an, an expected situation. Uh, you're basically, you know, unable to increase any more or once you're at that capacity. So that lends itself to needing more cash reserves. Another factor related to income would be what is, what percentage of that income is being saved versus spent. So if you're spending 99% of your checks every month, that's, um, you're very reliant on your job. So there's not a lot of wiggle room that lends itself to needing more cash reserves. And then I mentioned, uh, income security. So like how secure your income sources, let's say, uh, you have a pension from the government, that's an ultra secure source of income and you're living off of that. So that lends itself to needing less cash reserves. On the other hand, let's say you have started your own practice, uh, or maybe you're new at a practice.
Speaker 1 00:08:25 This, uh, that's a little bit higher risk income source. Another one really income would be how diversified are your income sources. If you have like lots of income sources, that's kind of like income diversification. So that's a lower risk setup. You have to have, you basically have to get fired a lot of places, um, you know, to lose your income because your income is your biggest source here. And so the more diversified your income, the less need there would be for cash reserves. Versus if you just have one job, you know, that might lend itself to having more cash reserves. Another factor would be the backups that you have, like the backups to the cash. Like if you have a whole lot of relatively liquid investments, they shouldn't be your rainy day fund. But, um, if you have a lots of different options outside of your cash reserves, that's kind of a little bit lower risk set up than someone that might have no investments at all.
Speaker 1 00:09:27 And then one other factor I'll mention is, um, a lot of, a lot of you guys probably have contracts, employment contracts, where if you leave early, you potentially might have to write a check for like a forgivable loan or something like that. So that's, uh, that's definitely a higher risk factor. So you want to kind of work that into the equation that lends itself to needing more cash reserves for your rainy day fund. Cause if you, you know, worst case scenario, you lose your job or you quit your job. And on top of not having an income, you're going to have to write a check. So you want to look at all those factors for your situation and start to iron out, like what a good target would be for you. So I'll throw out some examples or scenarios to help you start to boil this down.
Speaker 1 00:10:11 So let's say you're in training, you're single. You own really absolutely nothing other than let's say a bike and maybe some, some furniture in and you rent. And you're in a, of course, a very secure job on top of that, let's say you have a very high savings rate. And so given all those factors, like that's a very, very low risk situation. And so you can get by with a very low cash need. So, uh, let's say the target you said is, um, two months of expenses and maybe you spend 2000 a month. So maybe your rainy day fund target is $4,000. And that's plenty on the other end of the spectrum, maybe your, uh, in practice and your you're working for a brand new practice. Um, and you just started, and maybe if you, uh, maybe in your contract, you've got a $25,000 sign-on bonus, but it requires you to work there for a few years.
Speaker 1 00:11:13 So if your job blows up, you owe 25,000 on top of that, you're married, you have five kids, two houses, five cars, you've got a lot of stuff that could, could break or cost money, and you have a high spending rate. So you're spending most of what you take home. Those sorts of factors are all higher risk factors. So that translates to higher need for reserves. And so maybe in this situation, you're like your six months is the target you establish. So plus, plus maybe you have 25 on top of that to, uh, cover you if the job blows up. And so let's say you spend 10,000 a month. So 60,000 plus 25, 70, 80, 85,000 is your target that you establish. So that hopefully gives you kind of an idea of, of what that might look like. It's you want to kind of start to look at all those factors, figure out where you are on the spectrum.
Speaker 1 00:12:06 The more of those that you have that are higher risk factors, uh, the higher, your, a number of months you should be covering should be okay. So once we have a target established, the next thing would be to make sure you're holding it in the right place. I think this is pretty straightforward. It needs to be safe and secure and, uh, not volatile. It needs to be there if you need it, even in a really bad situation or bad market, is it the best place for this kind of thing? Is it just, just a bank savings account? There's really not much else safer than, than that. And so ideally you use just a good old fashion, uh, savings count. Maybe you find like a high yield savings account. I'll circle back to that in just a second, but, uh, just using a savings account is key.
Speaker 1 00:12:54 So some of the mistakes, I thought it would be good to, to explore some of the most common mistakes that we see related to emergency reserves. So you can try to avoid these. So one of the most common ones, the first one is just, co-mingling your savings accounts, your rainy day savings with other savings accounts. A lot of times we see people, they just have one savings account and maybe some of it is for emergency reserve. Some of it is for a house down payment fund, maybe some of it's for vacation fund or whatever other stuff that they have. So what happens is even if you've done like a really good job of establishing your emergency reserve target, let's assume we'll give you the benefit of Val that you've set that target. What happens is when you combined it all together, you forget. I mean, I forget, I can't remember what happened yesterday.
Speaker 1 00:13:45 So you're going to, you're going to forget after a while, um, you know, what that target is. And so it tends to lend, lend itself to, um, spending for non-emergencies for like, uh, you know, stuff you didn't have to spend on, especially if you're a spender type you're gonna of kind of lean towards spending too much of that. As you forget that target number. On the other hand, if you're a saver type you're going to probably lean towards not spending or kind of letting it build up too much. So ideally you have it a completely separate savings count and you call it like the rainy day fund or the emergency fund or whatever you want to call it. But it's, you know, it's there it's purpose. It's very clear. You never forget it. It's a round dollar amount and it's exactly what it needs to be.
Speaker 1 00:14:36 And if it's not, you're working towards that number, another mistake we see is people are trying to get a return or kind of maximize the investment aspect of their rainy day fund. I think you shouldn't really think of it as an investment. Like I mentioned before, it should be kind of viewed as an insurance policy, how people do this sometimes is they push the envelope on. Maybe they invest it. Maybe they invest in safer stuff. Uh, but it's not ultra safe. I don't think that that's a good idea. Ideally, if it's the purpose of it is to be available even in the worst case and potentially tomorrow. And so in order to, to have that meet that, uh, demand, you have to have kind of a, just a good old fashioned savings account. Sometimes people like to try to use debt as kind of a alternative to an emergency reserve, like a hilar or sometimes even credit card debt.
Speaker 1 00:15:29 I think the problem there is that you're not in a complete control over whether or not they allow you to continue to have the line of credit. Sometimes lenders will close them or not renew them. And especially in like a bad market, or if you lose your job, like no bank is going to want to allow you to continue having, you know, opening new debts. If you have lost your job or you're in a tough spot. And so using debt is a risk, probably not a good approach. And on top of that, if you do get into pinch, you end up having debt on top of being in a pinch. Another mistake, we see people over time tend to, once they set these numbers, they set it and forget it. But it's something you want to adjust over time. Most people's a rainy day fund targets will evolve over time.
Speaker 1 00:16:21 And so ideally you're revisiting it every so often. I think a one, you know, every one to two years is a good kind of target on that. So for example, let's say you started in training and like that example, we looked at a minute ago, like your target is $4,000 and then three years later, you're in practice. That second example, you have children and you're, you know, everything's changed and maybe your numbers bumped all the way up to like 85,000. So you want to every so often make those tweaks, or if life changes, like if you have big life changes, you, you definitely want to adjust it around those times as well. Like going into practices is a classic example. Most people's numbers will go up, uh, as they have those big life transitions. The other little mistake that we see, um, this is not massive, but it's definitely, um, something that's, uh, that happens is, is not getting really any return on your emergency reserve.
Speaker 1 00:17:16 So you don't want to, uh, try to get too greedy with it, but you also want to, uh, maximize the return for a savings account. So you can use like a high yield savings account and get a really competitive return on that. So right now interest rates are really, really low. So even in that higher yield savings count, you're still only going to get like a half a percent, but it's better than most brick and mortar bank savings accounts, which are basically like 0%. So you can Google like, uh, high yield savings accounts. There's a bunch of them now, uh, even with the big financial institutions and they're going to be paying typically much more competitive interest rates and that allow you to get a little bit more return on it. Like I said, you're not going to get rich on your emergency reserves. Uh, but you might as well take advantage of that.
Speaker 1 00:18:03 The last mistake we see is people using, uh, estimated expenses for calculating their, uh, rainy day fund instead of using actual expenses. So what I mean by this is if you've ever tried to, um, figure out what your expenses are typically, what, what people do. I've done this myself a million times as you're like, okay, let's figure out expenses. You start writing them down. You, you just, you think of as many expenses as you can. Maybe you look at your bank, shout out. You're like, okay, got that, got that total it all up. There's my expenses. The problem with that is almost always your estimated. So it really that's estimated expenses. Your estimated expenses are almost always underestimated. And so you need to, you should, you need to make sure you're using actual expenses. If you're going to do it like this, the best way to do that is to look at the past few months, maybe three to six months, and you don't need to total, you don't need to go into each category and figure out exactly where your money's going.
Speaker 1 00:19:05 You just need to look at the total outflows. And so some banks make it pretty easy to do. Do you just want to look for total outflows for each month and look at the average, and then that'll give you a much more accurate estimate of what your average outflows are. Okay. So as we wrap up, I wanted to iron out the action items like w so what does this look like? How do you work through this? So remember the things that we talked about, the kind of the housekeeping things, if you have any of those, you need to make sure and zip those up before you even start to dig into building your rainy day fund. So credit card debts, um, having like a one month buffer in your checking account. So once you're there and you're ready to build up your emergency reserve, think about the factors that we talked about, the risk factors.
Speaker 1 00:19:57 So maybe you don't have much risk, so you can go on the lower end of the spectrum. Maybe you have one to three months of expenses covered as your target, or maybe you're on the high end of the risk spectrum. And you need more like six to nine months of expenses in your reserves. Also make sure you're using actual expenses instead of estimated expenses. And like I said, if you don't know what those actually are, take a look at like prior bank statements to try to get a handle on average outflows. And so use that average outflows average over the past six months and multiply it by whatever number of months you need to keep in reserves. And this'll give you your target rainy day fund. So once you have your target, if you're under the target, make a concrete plan for like how you're going to get there, what you're going to do to, to make it happen.
Speaker 1 00:20:48 Maybe the timeline, what it's going to look like. And then once you hit it, you want to have a, you want to revisit the plan because typically you're going to have some reserves, maybe some extra money to work with, and you want to redirect it somewhere else. If you're over on cash reserves, you want to make a concrete plan now for like, what are you going to do with the extra cash? You need to put it to work for you so that it's, um, it's actually, uh, gonna return for you. Maybe you use that towards like major purchases that you want to do, or maybe you use that extra towards investing, or maybe you use that tool to paying off debt, or maybe you give, but the main thing is, is putting those dollars to work so best of luck and filling up your rainy day fund.
Speaker 1 00:21:35 I hope this has been helpful. Hit me up. If you have questions or want us to dig into more specific topics on this as always, it's, it's been a, been a good time catching up on this and we will, we'll look forward to seeing you next time as always, thank you so much for joining us today. If you found this valuable, please give us a review on iTunes and share with a friend. Also check out our website at finance, for physicians.co for all sorts of additional content. See you next time. Finance for physicians is not an investment tax legal or financial advisor. All content included in this podcast is for informational purposes only and should not be considered financial tax or legal advice. Material presented. It is believed to be from reliable sources and no representations are made by finance for physicians as to another party's informational accuracy or completeness, all information or ideas provided should be discussed in detail with an advisor accountant or legal counsel prior to the implementation. If you don't have an advisor or like a second opinion, feel free to check out our website for recommended advisors.
