This is the 2nd step of 3 in The Financial Engineer's Money Management Workflow. It is important to establish the difference between saving money and investing money, as this page is not intended to discuss how to invest money. This page will discuss saving money.
Saving Money vs. Investing Money:
I like to think saving as leaving your money in a passive state, or not putting your money to work by allowing it to grow and make more money (provide returns). I will try to put it in different terms and cross-reference it with my engineering background. I often say that monies saved are dollars with potential energy. This is money that is very accessible (high liquidity), has low risk, but provides low return. Investing is allowing your money to work for you by growing and providing high return. I often say that monies invested are dollars with kinetic energy. This money is active as it is used to provide financial returns at a controlled risk level. This money is not intended to be liquid, depending on the investment type, and should not be touched.
Intent of Saving Money:
The intent of savings is to be immediately accessible to pay for emergencies or short-term financial goals. Most financial gurus say you should have somewhere along 3-6 months of monthly expenses saved for. Well, another financial crisis is hitting us extremely hard due to the Coronavirus pandemic. This is the second financial crisis in 12 years… I would say 6 to 8 months of expenses covered would be a more comforting value to carry. This is coming from a guy who has a family, mortgage, and more responsibility than a younger individual fresh out of college or trade school. Each person’s savings should be assessed accordingly. It is important to get an emergency fund built before significantly investing money. Side note: I am also trying to stay extremely liquid during a pandemic that may result in an opportunity to buy real estate at a huge discount!
Having money saved is crucial during times of uncertainty and volatility. Savings will bail you out of economic crisis and relieve you of some stress during times financial storms. I am writing this page at 5:00AM on April 15, 2020, and according to numerous publications, there are approximately 16 million people who have filed for unemployment this month. This is due to the current Coronavirus pandemic, which has slammed the breaks on the roaring economy. Personal financial stability is crucial during tough times.
If you do not believe in a solid savings, than why does The Federal Reserve annually assesses our country’s largest bank holding companies to ensure they have adequate capital to continue operating during times of economic and financial stress. They must have:
“...robust, forward-looking capital-planning processes that account for their unique risks.” - The Federal Reserve.
If big banks operating in the United States are required to have significant capital to survive downturns, don’t you find it reasonable to do the same? Every individual has their own risks to consider, which should be reflected in their emergency fund.
Awesome! You have read through The Financial Engineer's 2nd step of 3 in his money management workflow. Please feel free to read up on the third step, Investing Money