By Jared Barkmeier, CFP®, Associate Financial Planning Consultant
A common question we receive from clients is “how much cash should I have?” It is a simple question that can have a complicated answer because there is no single answer. Different people have different specific needs that vary depending on marital status, children, income, expenses, and investments. We generally look at life stage when determining the proper cash balance. There are three life stages to think about when determining how much cash to hold; the working years, early retirement, and retirement. The proper amount of cash on hand can help a financial plan run smoothly and provide piece of mind.
The working years
One’s working years are between the ages of 20 and 65 but can vary depending on the person. During this time the person will have active income and expenses as well as savings for large expenditures and retirement. This group should generally have about three to six months’ worth of living expenses saved as cash. This cash balance is an emergency fund and can keep someone in their current lifestyle for a period of time between jobs or through an illness. The cash balance should be higher if there is a plan for a large expense in the next two years. Expenses like down payments on a home or a new car should be planned for well in advance and the cash balance after that expense should remain at the three- to six-month level.
Early retirement is categorized as the few years preceding and after retirement; this will generally range between the ages of 60-75 depending on retirement age. During this life stage we would like to see about two years’ worth of living expenses saved in cash. This is primarily to protect against inadvertent market conditions that may negatively affect investment savings. This cash balance is designed to act as a cushion to allow the investments to recover without needing to take withdrawals while the market is down.
Retirement usually begins around the age of 65. Much like early retirement, we generally want to see at least two years’ worth of cash. During retirement most income is going to come from investments, Social Security and qualified retirement accounts. Having a level of cash that could provide support for two years or make up a difference between a required minimum distribution and living expenses is key. By withdrawing the difference from cash rather than a qualified retirement account, additional income taxes can be avoided, potentially keeping a retiree from jumping to the next tax bracket.
Other factors to consider
While cash needs will vary from person to person depending on specific circumstances, holding too much cash can lead to negative impacts on a financial plan. Cash is generally one of the lowest growth assets you can hold and can reduce overall investment gains. This effect is compounded the younger a person is. Another factor to look at is FDIC coverage. Holding too much cash in the same account could put you over the FDIC coverage limits. Where you hold cash can also play a significant role in a financial plan. For instance, CDs may pay a higher rate on cash but are less liquid than a savings or money market account. When considering an emergency fund, CDs are generally not the best option for liquidity. CDs may be a better option for long-term savings goals like a down payment on a home.
If you have questions about how much cash you should hold, contact your HKFS financial planning consultant to go through a GPS plan to help determine the amount needed, as well as determine the proper cash vehicle.