Pop quiz: How much cash should you be holding?
- A) 3-6 months of your monthly expenses
- B) 1-2 years of your expected withdrawals from savings
- C) Cash is king -You should be 100% allocated to cash
If you hold too little, you risk needing to rely on credit or having to liquidate investments. Having to liquidate investments could be costly, either in fees and expenses, or in “realized loss” if the investment happens to be depressed based on the market. If you liquidate, you remove opportunity for it to potentially recoup those losses.
If you hold too much cash, you risk “opportunity loss.” Perhaps you could have collected interest elsewhere in the market? Perhaps you’re “safely losing money” due to inflation rates being higher than your interest (the purchasing power of your dollar is going the wrong direction)? Perhaps you may have had other tax deferral options?
I’d be interested to know how you answered the pop quiz. It would tell me a lot about you, your goals and how you feel about money. All the answers are correct, depending on who you are. The correct answer, for you, requires a conversation and understanding of cash’s purpose and fit in your financial plan.
Generally speaking, I still say cash is king, so err on the side of having more versus having less. There are plenty of reasons to hold more, things you may not think about day to day:
- Do you have adequate disability insurance if you are too sick or injured to go to work?
- Do you have required minimum distributions coming up that would require large withdrawals from investments?
- Do you have a home equity line of credit you could rely on for quick access?
- Are you a one-income household?
- Is your compensation variable or no?
- Do you have other planned expenses that aren’t a part of your monthly expenses (i.e. fix the roof, tires for the car, new appliances)?
While working, keep 3-6 months of your monthly expenses in cash for emergencies and opportunities, maybe more if you’re one-income household or have variable compensation. When retired, keep 1-2 years of savings withdrawals so no matter the market movement (market downturns historically last 18 months on average) you have available cash for an emergency or that trip to Paris.
But no matter what, be sure you know how you feel about money. Do you prioritize return ON your money, or return OF your money? If it’s the latter, than option ‘C’ above may be best for you and cash will always be king.
Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. Please consult a financial professional prior to taking any action.