Building a cash buffer

Quick insights

• A cash or financial buffer is an emergency fund set aside to cover unexpected expenses or a loss in income.
• The buffer generally covers three to six months of living expenses, though the amount may vary based on factors like income stability and medical needs.
• Keeping the funds in a designated savings account may help prevent unintentional spending.

A cash buffer serves as a financial cushion that can be accessed during unexpected financial difficulties. Surprise costs, such as medical bills or car repairs, can be expensive and may lead to debt. When these unexpected expenses occur, a cash buffer may minimize your reliance on credit in many instances.

Here’s what a cash buffer is and how you can start building one.

What is a financial buffer?

A financial buffer—often called a “cash buffer”—is an emergency fund that’s set aside in case of financial emergencies or unexpected expenses.

Experts generally suggest saving enough to cover three to six months of living expenses, though individual needs may vary based on financial security preferences. Some people may choose to store their cash buffer in a dedicated savings account for easy access during emergencies.

This emergency fund may act as a buffer, potentially helping you avoid taking on debt in the event of a financial crisis. Some people feel more secure when they have this financial safety net in place.

If you have existing debt, you may wonder if you should pay off the debt or start saving first. The answer depends on individual financial circumstances. For example, some people may prioritize paying off high-interest debt before starting to build a cash buffer because they want to avoid paying interest charges.

What influences your cash buffer size

What is a good financial buffer? It depends. While some people may feel secure with an emergency fund that includes three months of living expenses, but others may want to have enough in savings to cover as much as a year’s worth of expenses.

How much you need in your emergency fund varies based on several factors, including your own comfort level. Here are some things to consider as you determine the cash buffer size that works for you:

• Income stability: The consistency of your earnings plays a role. For example, freelancers with fluctuating income may wish to have a larger buffer whereas some full-time employees in reasonably stable industries may feel comfortable with a smaller buffer.
• Family dependents: If you have children or other dependents who rely on you financially, a larger emergency fund could make sense. This may help you accommodate any additional emergencies that could arise.
• Medical needs: If you or anyone in your family has a health problem, a larger financial buffer could potentially help account for the costs of any potential medical emergencies.

How to build a cash buffer

Building a cash buffer is part of managing your personal finances. While saving money can be challenging, breaking the process into small steps may make it more manageable.

Evaluate your financial situation

The first step is typically to determine what your monthly expenses are. You can calculate this by assessing how much you need for basic expenses, such as housing, utilities, groceries, insurance and any other essential payments.

Since this figure generally doesn’t include non-essential expenses, it’s possible this number will be lower than your current monthly budget.

Set a target

Once you’ve settled on a figure for your monthly essentials, the next step is to multiply that number by how many months of a buffer you would like. So, if your costs for monthly essentials are $3,000, then a three-month buffer would be $9,000.

If the figure you arrive at feels intimidating, you can always settle on a smaller amount for your initial goal and then reassess once you achieve it. A small buffer may be better than nothing.

Another option is to look for opportunities to cut back on expenses so that you can put more money toward your cash buffer. For example, you could try to cut back on dining out or work to lower your heating bill during colder months until you’ve reached your savings goal.

Create the fund

You’ll need a place to keep your cash buffer. It can be confusing to keep your emergency fund in your checking account. A dedicated savings account for your cash buffer may prevent you from accidentally spending it.

Since people usually want quick access to their cash buffer in the event of an emergency, they often prioritize account accessibility when comparing the features of different savings accounts. Transferring money from your checking account to your savings account may be faster if the accounts are with the same bank.

Determine a funding strategy

Once you’ve identified where you’ll keep the savings, the next step is to determine your funding strategy. Here are some questions to keep in mind as you develop the strategy:

• Where will the funds come from?
• How often will funds be transferred to the account?
• How much will be transferred?
• How quickly do you want to reach your cash buffer goal?

For example, someone who is paid biweekly may decide to set up an automatic transfer of 5% of their paycheck from their checking account to their savings account on paydays.

People typically treat these funds as untouchable outside of legitimate emergencies.

Reassess your strategy periodically

Financial or other life events can alter your funding strategy. Here are some events that may cause you to reassess how much you need in your cash buffer:

• Changes to your expenses or income
• Additional financial dependents
• Increased medical costs

Additionally, if you have to use your cash buffer, you can assess how quickly you’re able to replenish it to its original levels.

Of course, once you’re satisfied with your cash buffer, there may not be a need to keep adding to it, and you can start thinking about other aspects of your long-term financial planning.

In summary

A cash buffer acts as a safety net in the event that you face a financial crisis. It’s typically an emergency fund that includes three to six months of living expenses, but some people choose to save more.

Keeping your cash buffer in a separate savings account could help you avoid accidentally spending it. Once you’ve built up this emergency fund, you can start thinking about other savings goals like a new house or your next vacation.