A financial cushion is the most boring financial instrument of all and, at the same time, the only one without which the rest do not work. It is easy to describe in one sentence: it is money that sits idle so that you are not forced to sell assets or take out a loan at the worst possible moment. However, there are several details that determine whether it will work or not.

Exactly How Much

The standard guideline is 3–6 months of your expenses. Pay attention to the wording. The calculation is based on expenses, not income, and this is fundamental because a person earning UAH 50,000 and spending UAH 30,000 needs a financial cushion of UAH 90,000–180,000, not UAH 150,000–300,000. The specific figure within this range depends on your situation. Three months is enough if you have a stable job in an in-demand profession, live without dependents, and have someone you can ask for help in an extreme situation. Six months is necessary if your income is unstable, such as in freelancing or running your own business; if you are the sole breadwinner in your family; if your specialization is narrow and finding a job takes a long time; or if you have credit obligations. More than six months makes sense for people approaching retirement age, those working in a shrinking industry, and business owners with seasonal income.

How to Calculate Your Figure in 10 Minutes

Do not estimate your average monthly expenses from memory, because memory underestimates them by approximately a quarter.

Take your card statements for the last three months, add your cash expenses, and divide the total by three. Then subtract the expenses you would give up if you lost your income, such as entertainment, subscriptions, trips, and clothing purchases. The resulting figure represents your expenses in survival mode, and this is the amount you need to multiply by 3–6. People usually discover that this amount is 30–40% lower than their usual expenses, meaning they need a smaller financial cushion than they thought. Add any mandatory payments that will not disappear, such as rent, utilities, loan payments, medication, and expenses for children.

Where to Keep It

The main requirement is not yield but accessibility within 24 hours. A sensible distribution looks like this. Keep part of it in cash, and in Ukrainian conditions, this is not paranoia but a necessity, because terminals do not work during prolonged power outages. A guideline is enough to cover 1–2 weeks of expenses, with some of the money in hryvnias and some in foreign currency in small-denomination banknotes. Keep part in a card account for instant access. Keep the main portion in a deposit with no restrictions on early withdrawal or in a savings account. The interest rate there is lower than on a fixed-term deposit, and this is a normal price to pay for the ability to withdraw money at any time. The foreign-currency portion protects against devaluation, and its share depends on the currency in which you spend.

Where You Must Not Keep It

Do not keep it in stocks, cryptocurrency, or any assets whose prices fluctuate. The reason becomes obvious upon closer examination: the need for a financial cushion most often arises during a crisis, and these assets tend to fall precisely during a crisis. This means you would be selling them at the worst possible moment, which is exactly what the financial cushion was supposed to prevent. Do not keep it in a fixed-term deposit that incurs a loss of interest when withdrawn early, because you will either lose income or delay accessing the money when you need it. Do not keep it in government bonds, despite their high yield, because before maturity you must either hold them or sell them on the market at the current price, which may be lower than the purchase price. Do not keep it in real estate, because it is impossible to sell within a week without a substantial discount. Do not keep it in money you have lent to someone. Do not keep all of it in one place, because a bank may experience technical problems precisely when you need the money.

The Main Misconception

People reject the idea of a financial cushion on the grounds that money loses value and should be put to work. This is true, and it does not matter. A financial cushion is not an investment and should not generate income. It is insurance, and the cost of this insurance is precisely the income you forgo. Let us calculate how much this insurance costs. A financial cushion of UAH 100,000 earning 8% instead of 16% forgoes approximately UAH 8,000 per year. Now let us calculate the alternative. A person without a financial cushion who loses their job takes out a consumer loan at 40–60% annual interest or sells assets at a loss. Three months on a UAH 100,000 loan costs approximately UAH 10,000–15,000 in interest alone. In other words, the insurance costs less than a single situation for which it exists.

When You Can Spend It

This question is more important than the previous ones because this is precisely where most people's financial cushions disappear. A financial cushion is used to cover a loss of income, urgent medical treatment, an emergency breakdown of housing or equipment that is essential for living or working, and an emergency need involving loved ones. A financial cushion is not used for a vacation, equipment that has simply become outdated, a good offer available for a limited time, a renovation that was planned in advance, or an investment opportunity that you would hate to miss. The last point is the most insidious because it looks rational but actually turns insurance into a risky bet. The working rule can be formulated as a single question: Will something bad happen if I do not spend this money within the next month? If the answer is no, this is not a situation for using your financial cushion.

What to Do After Spending It

The financial cushion must be replenished, and this takes priority over any investments. In practice, this means that after using it, you return to saving until you have restored the amount, and only then return to investing. It is also useful to review its size, because the situation that forced you to use the cushion has shown whether it was sufficient.

If You Have No Financial Cushion at All

First, accumulate a small buffer covering approximately one month of expenses, because this already covers most minor unexpected costs and eliminates the need for a credit card. Next, pay off expensive debts, meaning anything with an interest rate above 25–30% per year. Repaying such debt is an investment with a guaranteed return equal to its interest rate, and no financial instrument can outperform it. Then build your financial cushion up to three months of expenses. Only after that should you start investing, while continuing to build the cushion toward six months of expenses. Violating this sequence leads to a situation in which a person invests while simultaneously paying interest on a loan, meaning they operate at a loss. I have written about the mechanics of saving and the available instruments in separate articles.

The Specifics of Our Conditions

Having cash matters more than elsewhere because during prolonged power outages, cashless payments may be unavailable for several hours or longer. Distributing money across banks and currencies makes sense not only in terms of yield but also in terms of accessibility: technical failures and restrictions do occur, and keeping everything in one place is risky.

Summary

A financial cushion is calculated based on expenses in survival mode, not income, and for most people, it turns out to be smaller than they think, by approximately 30–40%. It should be kept where its value does not fluctuate and where it is accessible within 24 hours, namely in a savings account, a deposit without withdrawal restrictions, and partly in cash. The income you forgo is the price of insurance, not a loss. The main spending rule can be formulated as a single question: Will something bad happen if I do not spend this money within a month? This is because good opportunities and planned purchases are precisely what cause most people's financial cushions to disappear.

Sources

Generally accepted guidelines for the size of an emergency fund in financial planning, data on consumer loan and deposit interest rates. The calculations of the cost of insurance were performed by the editorial team.