What reserves!

Posted: Jul 18, 2006 12:00 AM

When I talk to people about their financial situation, I always include the question:

"What about reserves—do you have any?" Even though I generally talk through my computer or on the telephone, I nevertheless feel that the person to whom I am talking has a slight tightening of the neck muscles.

Let me rank the responses I generally get:

1. no
2. some
3. I'm pretty liquid at this moment
4. I have an equity line to draw on as I need it.

Number 3, if you are keeping track, is definitely the best answer. Numbers 1,2 and sometimes 4 really should not be acceptable. I am not speaking about acceptable to me but acceptable to you! Living without reserves, or better yet sufficient reserves, is tantamount to a voyage on the Titanic without a life vest. This world is full of surprises, many of which come from Mother Nature, some from Father Time, and the rest from any variety of human sources. What are proper reserves? Six months income in the bank would be the best answer to the question (gross income, not after tax) if you are planning for a secure future.

For example, if you make $5000 a month gross then you should have $30,000 and if you make $15,000 in earnings then you need $75,000, etc. For most people, however, that answer is as difficult as if I had said $1 million.

Truth be known, it really shouldn't be difficult if you have a house—better yet a house with a lot of equity. Therein lies your answer.

Now to finish the thought I said that sometimes #4 falls into the unacceptable category and the reason is as follows: If your house is in an area (can be as big as an entire state) that is hit by a disaster, you may find that trying to take money out of your equity line is futile. Lenders want to know that the collateral is still in tact. During a disaster, they can freeze your equity line until an appraiser can attest to the fact that the property is still in the same shape it was in when the line was approved. When you most need to get the money you may not always be able to get to it.

Understanding this concept and putting away the necessary reserves can be your lifeline in a time of crisis. For more information click here.