Perhaps you have heard the saying cash is king. There is a degree of truth to this statement. Just keep in mind that if cash is king, that inflation (if not held in check) is the ever-lurking enemy that can quickly take over the kingdom.
For the sake of argument, I am going to assume that inflation is around 4% or less. If inflation is in the double digits or higher, then it very well could be this whole article should be disregarded.
What do I mean by Cash/Cash Equivalents?
Cash equivalents are items that can be liquidated within a 3 month period of time with no risk as to its value. These can include money in a checking or savings account, money market accounts, Treasury bills (T-bills), and CDs with a maturity of 3 months or less.
How Much Cash Should I Have?
The amount of cash that you should have varies on a number of factors. Factors include your expenses, how soon you are to retirement, the steadiness of your job, the nature of your investments, and the amount of large purchases you plan to make.
The Standard Answer (For Those with Steady Incomes)
Financial planners recommend that people maintain 3-6 months’ worth of expenses as an emergency reserve. When expenses are listed, this does not include taxes or savings. It does include everything else.
If something goes wrong, then you would have some time to hopefully find a new source of income. Is this guide of savings bulletproof? By no means, but it is a reasonable place to start. I find that though this can be a good recommendation for those with steady incomes, this may not be adequate for those who experience highly fluctuating/variable incomes throughout the year.
For Those with Highly Variable Incomes
Now, for my clients that have highly variable incomes, I have two different avenues to consider:
1.) Keep your expenses below your lowest paid quarter. Then follow the standard recommendation of having 3-6 months’ worth of expenses as an emergency reserve.
2.) Feel free to have expenses that are below your average monthly income for the year. Have 6 months’ worth of cash/cash equivalents in emergency reserve and an additional 6 months of expenses in short term investments.
It is acknowledged that there are good months and bad months and good years and bad years. Having the extra reserve helps mitigate some of the pain you may otherwise experience and may make things feel steadier rather than feast or famine. In a later post I will talk about having a filter account and how to make this work.
For Those Who are Soon to Retire/Retirees
I would strongly recommend those who are in retirement or those who are nearing retirement to consider having at least 6 months of worth of expenses in cash or near cash equivalents in their savings. In addition, I would recommend retirees to have 6-54 months’ worth of short term investments. On the other hand, I would question the wisdom of having much more than five years’ worth of expenses in cash or cash equivalents.
You are placing yourself and your livelihood to the vicissitudes of the market and the economy. Having enough money in place to weather downturns in the market which can last greater than a year is prudent. On the other hand if you have over five years’ worth of expenses in cash or cash equivalents, there is a strong chance that inflation is eating at your purchasing power.