Why is important to have a cash reserve?
You should have a cash reserve for three reasons: to avoid running up credit card debt to cover unexpected expenses, to have funds on hand to cover your living expenses for a while if you lost your job, and to have money available to take advantage of an investment or other buying opportunity.
How much should someone keep in a reserve?
A good rule of thumb is to have from 3 to 6 months of living expenses in a reserve. If your income is steady and your job is secure, then 3 months might be fine. But if your income fluctuates or your job isn't secure, then you should err on the side of caution and build a larger reserve.
How should someone balance the need to keep the funds liquid – so they can be accessed quickly – with the desire to earn higher returns?
Your cash reserve should have several levels in order to strike a balance between liquidity and higher returns.
Checking Account: Keep enough in your checking account to avoid bouncing checks and overdraft fees.
High Yield Savings or Money Market Account: This can be at your local bank or online, but make sure it's linked to your checking account so you can transfer funds back and forth easily.
Certificates of Deposit (CDs): Earn higher interest rates but have early withdrawal penalties.
No-Load Short-Term Bond Fund: Will have a higher yield, but your principal balance will fluctuate so it shouldn't be used for money you're planning on spending soon.
Remember that these topics are general in nature, so consult with your financial advisor about your specific situation before making any investment decisions.