The Scenario Chart for Months of Reserves shows us the total number of months we could go without running out of money based on the current Total Account Balances divided by the Total Operating Expenses plus the Total Mortgage Payments plus the Personal Expenses Excluding Real Estate from any Rules in the Scenario.
Months of Reserves = Total Account Balances / (Operating Expenses + Mortgage Payments + Personal Expenses)
Recommended Months of Reserves
Historically, when we've taught real estate investor classes we've talked about the importance of having at least 6 months in cash reserves in your bank accounts when buying a new property. We used to debate whether you really need 6 months of reserves per property when you have a larger number of properties. I was, meekly, on the side of wanting you to have more in reserve but I never really pushed too strongly on that point. And personally, I've had far greater than that in cash reserves after my own personal bankruptcy and foreclosures.
Now that we've seen the devastation of COVID-19, I will be pushing back harder now.
Formally, now I suggest you keep, at a minimum, 6 months of reserves including all mortgages and operating expenses and your personal living expenses.
And, for those that want to be even more conservative: 2 full years of reserves for each property and your personal expenses.
Ideally, this money should be stored in an account that is not subject to market risks (like the stock market). For example, a savings account.
However, if you have more than two times what you need (in this example – 4 years of reserves) then I'd personally be comfortable keeping that in index funds in the stock market. This double the amount you need will give you a margin of safety should there be a simultaneous decline in the stock market and a need for reserves.
I think prudent investors would keep some in the stock market and some in savings. I personally like to have 6 months in savings and the rest (more than 2 years additional for me) in index funds in the stock market.
The following is an example of a Chart showing Months of Reserves when comparing two similar
And here's an example of Months of Reserves from our class on How to Go Broke Using the BRRRR Strategy.
The following is another example of Months of Reserves from the class on How to Achieve Financial Independence and Retire Early Starting with Nothing But Grit and Tenacity. As you can see, this one has you operating with very little in reserves early on.
If you're interested in learning more about the Scenario Charts in the Real Estate Financial Planner™ check out these resources below.
- Average Rent Resiliency™ Dollar
- Average Rent Resiliency™ Percent
- Cash Flow
- Effective Income Tax Rate
- Gross Paychecks