Financial Cushion: What it is and How to Form it

The phrase “financial cushion for the family” can be heard more and more often from the mouths of reputable consultants and public figures. Financiers, business consultants and banks talk about the necessity of its formation – and no wonder: a competent attitude to money is important for everyone and helps to mitigate the consequences of even large-scale crises.

We will tell you why you need a financial safety cushion, what problems it can help solve, and why savings should be an important budget item by banker Кирилл Юровский.

What is a financial cushion

It is also called a “reserve” or “liquid fund. In simple terms, it is some fairly large amount of money that you save on a regular basis, not for any major purchases, but for unforeseen circumstances. In a prosperous period, you regularly increase the size of the reserve, saving a percentage of your income into it. But if, suddenly, a force majeure situation happens, when you urgently need money, you will be able to use the accumulated funds: they, like a safety cushion, will protect you from negative consequences. It is a way not to fall into financial disaster, even if something in your life goes wrong. That’s why it is recommended to make such savings for everyone, not only for businessmen and business people, but for everyone who has at least the slightest opportunity to save. What is an adequate amount of savings?

There are several rules that allow you to create a financial cushion of the right size.

  • Be guided by the peculiarities of your life. For example, if it will be easy for you to find a new job in case you lose it, and you know it, you can save a little less. If it’s difficult, it’s better to play it safe.
  • Age also affects your life. The older a person is, the larger the financial cushion he should have. Age imposes certain risks: possible difficulties with health or finding a new job.
  • Consider the financial health of your family members. If they earn good money and are not at risk of serious problems, the size of the cushion can be reduced a bit. If the risk of force majeure is quite high, and there will be no one to help you in unforeseen circumstances, the financial cushion should be large.

In general, it is believed that you need to save enough to be able to live a full life for 4-5 months, spending only the savings. Most often, this amount is enough to successfully overcome a period of lack of regular income. Read more about savings in this article.

What a financial safety cushion can help with

Surviving tough times

The year 2020 will forever be remembered for the financial and labor market challenges caused by the COVID-19 epidemic. Even after the epidemic finally subsides, its effects will affect the economy for a long time to come. No one could have predicted these developments: the virus appeared suddenly and was a factor that no one expected. Many people lost their jobs or businesses and saw their incomes plummet. Costs also increased. A difficult, stressful and unexpected situation was an ordeal for absolutely everyone – and it turned out to be easier to cope for those who had savings. Both businessmen and ordinary families, who had a financial reserve fund – that very airbag – endured the blow more easily. And now none of us knows what will happen tomorrow, but the experience we already have says: savings help maintain a standard of living and not to be left without a means of subsistence.

Stay out of debt

If a person urgently needs funds, which he does not have, he is very likely to go to the bank: take a loan for his needs. Sometimes a loan can even be profitable, such as with intentional use of credit card bonuses. But in the case of loans taken out in a hurry, for the sake of solving urgent problems, this almost never happens. As a result, a person loses money, gets new financial obligations, and if his or her life situation does not improve, may face overdue obligations, problems with creditors, and possible litigation. Having a financial safety cushion will prevent this from happening. If something happens and a person needs money urgently, they can use their own emergency fund and not borrow from anyone.

Be prepared for a force majeure situation

Having a safety cushion makes it possible to take life’s changes calmly, not to panic and to make better, more balanced decisions. This is another plus of savings: they provide stability, both financial and psychological.

Stay out of trouble

Sometimes there are truly scary situations that require an urgent financial infusion. In such cases, having an airbag can do more than just help maintain stability – it can save someone’s life or health. It is a very important and valuable tool that should not be underestimated.

How to accumulate a financial safety cushion

Financiers advise to live according to the 50-30-20 principle if possible:

  • 50% of your earnings should be spent on regular and obligatory needs;
  • 30% can be spent on occasional purchases or optional expenses;
  • 20% should be set aside.

We understand that not everyone can afford to regularly set aside one-fifth of their income, but that’s no reason to give up saving altogether. Even 5-10 percent of your salary is better than nothing. Especially if you put them at interest or otherwise protect them from inflation. To succeed, you must follow the main principle: building a financial cushion should be a priority spending on a par with paying liabilities and utility bills. Try to do this first, as soon as you receive your salary or other income. This will ensure that you do not forget to deposit the right amount into a savings account and do not neglect savings.

What’s the best way to store

There’s an old saying – “don’t put all your eggs in one basket.” That goes for money, too: financial literacy counselors say so first and foremost. Emergencies can come from any direction, so it’s best to divide your financial safety cushion into several fragments and store them separately. For example, like this:

  • part of the amount is at home in cash – however, not the largest, as this is not a very profitable way to store;
  • Part is in a savings account. This is the best option for most, as you can earn interest from your own savings and thereby increase your safety cushion. In addition, withdrawing part of the money from the account is not profitable and will lead to a loss of interest, which will prevent you from spending that money on non-target needs.

What else you should consider

Unfortunately, there are situations where even a solid accumulated amount is not enough to fully compensate for the risks. As a rule, these are very serious, often unforeseen events for which no one is prepared: for example, the person who earns the most in the family gets seriously ill. Financial literacy teaches you to anticipate such risks, too, so your safety cushion should include more than just savings. That way you’ll be better protected against unforeseen circumstances from all sides. What you can do:

  • Invest in assets that have low risks of depreciation, such as real estate;
  • Find additional sources of passive income;
  • Take out life and health insurance: sometimes this can be very helpful under difficult circumstances;
  • Plan in advance what to do in case of force majeure.

Of course, such actions will not save you from the risk that something can happen. But you will be more prepared for any circumstances and will not let them knock you out of your rut.

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