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How Much Cash Should I Hold?


How Much Cash Should I Hold?

Most people hold cash in some combination of checking and savings accounts at a bank.  The cash in these accounts is used to pay for normal everyday expenses throughout a typical month.  However, in addition to holding cash in checking/savings account to pay for bills, you should also consider having a separate savings account designated as an emergency fund.  This emergency fund won’t fluctuate monthly like your checking and savings accounts and the purpose of holding it is to be a buffer against an unforeseen event.  Having an emergency fund is something we recommend, but the amount of cash to hold in this emergency fund isn’t the same for everyone 

 If you hold too much of a cash reserve, it can cause too big of a “cash drag” on your net worth.  This is not a good idea.  The reason it is not a good idea is that cash generally earns little return, if any.  In many cases, after factoring in inflation, your real return on cash will be negative, which means that over time your purchasing power will diminish.  If you hold too little cash, you risk not having an adequate amount to protect yourself during an emergency. Typically, it is industry standard to hold somewhere between 3 and 12 months of expenses in an emergency fundGiven that wide range, the exact amount will depend on a few individual factors mentioned below: 

Risk aversion

Your risk tolerance can be a starting place for how much cash you feel comfortable holding.  How many months of cash do you need to hold for you to sleep at night? The more risk averse you are, the more cash you should hold. 

Number of income sources 

If both parents in a family are working, the potential of your income going to zero is lower.  It is possible to lose both sources of income simultaneously, but the odds of that happening are much lower than losing just one income source.  The lower the odds of income going to zero also lowers the overall need to hold more cash in an emergency fund.   

Volatility of Income 

Another consideration is the volatility of your income.  This consideration covers both the consistency of your income as well as the type of job you hold.  As an example, someone who has a 100% commission-based sales job should hold more cash in comparison to someone else who has a set annual salary.  The dependability of your job also is important.  If you work in a relatively “safe job” in an industry that isn’t cyclical, you have less worry about a pay cut or job loss if the economy takes a turn for the worse.  In this case, you can be comfortable holding less cash. On the flip side, if your job is in a cyclical industry that is more sensitive to the business cycle, it would be wise to hold more cash.   

Other sources of savings 

The last item to consider is other sources of savings.  One of those such sources could be a taxable brokerage account.  If you have money in a taxable brokerage account, you can withdraw money from this account without any penalty whereas if you only have retirement accounts, such as an IRA or 401(k), you could be penalized and taxed for taking money out before age 59 ½.  A taxable brokerage account gives you more flexibility in holding less cash as you can access the money in a pinch.   

One issue with relying on this account as an emergency savings is the timing of withdrawsIyou lose some of your income and you need to withdraw cash, you hope the need doesn’t coincide with poor market conditions.  The taxable brokerage account is likely invested in the stock market and in a perfect world you don’t want to have to withdraw money when the market is down as you would have to sell positions and take cash at the worst time possible.   

There is no one-size-fits-all solution to how much cash should be saved in an emergency account.  Although with consideration of these factors you can make a determination for what fits for your personal situation.



Written by

Jimmy Stechschulte, CFA®

As a member of the Investment Committee, he performs investment research on both equity and fixed income products to help construct diversified portfolios for clients. Jimmy also meets with and assists clients with financial and retirement planning needs, estate planning, and tax planning issues.

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