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The Voice of Moderation

“In life,” said he, “these were so squint of mind

  As in the handling of their wealth to use

No moderation – none, in either kind.”

—The Comedy of Dante Alighieri, L’Inferno,

In his tour of Hell, Dante confronts those who have been condemned for the sin of greed; and in particular, greed with regards to wealth. He describes the greedy as being closed minded and having no moderation. It does seem that wealth has that effect on many.

One of the basics of personal financial planning is moderation on both the planner and the client’s part. Some synonyms for moderation are self-restraint, self-discipline, and self-control. In recent years, as I have reviewed the work of other personal financial planners, I have seen a lack of moderation. The lack of moderation is often reflected in the amount of cash assets set aside for emergencies.

These dollars are used to provide protection for the unexpected and unanticipated events which occur in all our lives: the water heater breaking down, unemployment and a Market Trough. As I have reviewed financial plans, either there are no emergency reserves identified or the planner has chosen not to address this need.

Why is this the case? To be candid, there is no economic benefit to a personal financial planner, who is compensated for managing assets or selling products, to plan for a client’s emergency reserve fund.

If an adviser is not being compensated on those dollars, why provide the advice? And there is another reason: the client tells the adviser that the emergency reserve fund is established, when, it’s not. The personal financial planner should challenge the client on that assertion and ask what amount has been set aside for an emergency. This is acting in moderation.

How much should be set aside for an Emergency Reserve?  The rule of thumb is somewhere between three and six months of living expenses. Living expenses are defined as the amounts necessary to maintain hearth and home: installment debt payments, mortgage/rent, food, utilities, and the like.

Discretionary spending should not be considered in the calculation of the emergency reserve fund. If you have had an event—loss of employment for example—the last thing you should be doing is discretionary spending. Remember—moderation.

How do you decide between three and six months?  If you are married, and not working for the same employer (you have two sources of income) then three months is sufficient. On the other hand, if there is only one source of income for the household, then the goal for the emergency reserve should be six months of living expenses.