Finance Friday: Calculating a Safety Net

  • Finance Friday

What’s a Safety Net?

A safety net is money that’s either not invested (held in cash) or invested very, very conservatively (like a money market account) so that it’s available to be used in the event you lose your job or your business struggles for an extended period of time.

Here’s the general rule of thumb we use with our clients:

If you have a steady W2 job with a low probability of either being released, down-sized or fired, a safety net of 3-6 months is sufficient (most of our clients think three months is more than sufficient).

Small Business Owners

If you’re a small business owner, the range is a little higher.  It’s ideal to still have at least three months, but some choose to go as high as 12 months.  Here are some considerations for small business owners to think about when considering how much to keep in a personal safety net:

  1. If your business is highly volatile (higher end)
  2. If your business has a large number of small recurring clients (lower end)
  3. If your clients have signed contracts to do business with you (lower end)
  4. If revenue generation is dependent on other employees’ efforts (higher end)
  5. If you only have a few large clients that generate most of your revenue (higher end)
  6. If you’re a new business (higher end)
  7. If you have an established business with a good track record (lower end)
  8. If you’re personally risk-averse (higher end)

Calculating Your Safety Net

To calculate your safety net, add up all of your essential expenses for the month and multiply by the number of months you would like to keep on hand.  Do not include your discretionary spending in the calculation (such as movies, travel, dining out, entertainment, etc).  The idea is that you would be unlikely to spend money on these non-essential items if you lost your job and needed to live on savings (if you want money for these items during a period of unemployment, increase your safety net).

Keep in mind that there’s no magic number.  You need enough to feel comfortable, but not so much that you’re missing out on other investment opportunities.

2017-10-26T20:12:25+00:00

About the Author:

Tim Plachta, CFP® owns and operates Reliant Wealth Management and Reliant Consulting Partners.  He works primarily with small business owners to help them increase profit, reduce their workload (so they can relax more), and invest enough of their earnings to achieve financial independence.