How Much Cash Is Enough?
Holding cash and cash equivalents is necessary, but having too much or too little can jeopardize your goals.
As we emerge from the pandemic, your emotions are likely riding a rollercoaster. In recent months, there has been quite a bit of market volatility, which has tempted many investors to invoke a more cautious approach and hold more cash than usual. If you’ve ever wondered how much cash you should have on hand, you’re in good company. The majority of our clients have asked us this question through the financial planning process, during their annual portfolio review, or with an impromptu call or email.
What’s the Magic Number?
Unfortunately, there isn’t one, and this is because everyone’s circumstances are different. However, there are solid principles that can be applied to maximize your position. Depending on their specific situation, we typically advise our clients to hold between 6-12 months of a cash reserve. However, we know many clients have been saving more cash than ever. For many, this is because there haven’t been as many opportunities to spend discretionary income. For others, cash is held as a hedge to protect against future economic downturns. There are better solutions than having the money sit in your checking or savings account. Read on to learn more about strategies to help capitalize on your cash position.
Why Hold Cash Across Your Investments?
Cash offers security by being a liquid asset. As a part of a diversified portfolio, cash is a crucial tool for capital preservation, and during different times has been able to produce income through modest yields. However, our current economic state and the actions taken by the Federal Reserve have driven what is considered risk-free asset yields close to zero. Short-term interest rates have plummeted as there have been concerted efforts to keep interest rates low due to the economic fallout associated with the Covid pandemic. On the one hand, low borrowing costs have been an essential part of stimulating the economy, but on the other hand, investors lose out on yield with cash deposits. Although the United States dollar provides positive returns, we know that investors feel it can be difficult to find relatively safe havens that will outpace inflation. Many investors have moved into riskier assets because they are seeking yield and looking to outpace inflation. At Aevitas, our clients have diversified portfolios and well-planned allocations, which allows their short-term needs to be satisfied without jeopardizing longer-term objectives. As experienced financial advisors, our job is to ensure decisions about your money are made with logic rather than emotion or sentiment.
Determining How Much Cash to Hold
Deciding the right amount of cash to hold is not an exact science. However, in addition to working with the Aevitas team, outlined below are several considerations to help guide you to determine how much liquidity is necessary.
1. Your Emotional Safety Net: We provide highly customized advice to our clients based on what is best for their particular situation. We recognize that everyone’s comfort level is different, and the most important thing is that you are not up at night worrying about whether you have enough (or too much!) cash on hand.
2. Emergency Funds and Usual Expenses: It is important to determine the amount of cash you need to cover your usual expenses. It is equally important to have an emergency fund for unexpected costs and unanticipated events. The amount of money you need to keep will largely depend on your income, job stability, and individual tolerance for risk and illiquidity.
3. Significant Purchases and Financial Commitments: Are you planning to purchase a new car? Perhaps you have to pay a tuition bill. We will talk with you and help determine that you have the right balance of liquidity to pay for big-ticket items and service your typical expenses.
4. Opportunity: The market volatility experienced throughout the past 15 months is a reminder that the markets’ performance can turn on a dime. It is wise for many clients’ investment strategies to have adequate cash reserves to take advantage of attractive investment opportunities.
5. Minimizing Risk: Cash plays a vital role in balancing a portfolio and providing downside protection. Whenever possible, we want to plan ahead for portfolio withdrawals and do not want to place sales at inopportune times. Holding a cash balance helps allow for adequate planning for distributions and withdrawals.
Where and how Should I Hold Cash?
The concept of holding cash is simple, but the current yield environment can make it a less attractive asset class for many investors. Much like building a long-term investment portfolio, we think carefully about how to structure your cash positions and liquidity. There are successful strategies, with varying levels of yield and risk, that can be deployed for all timeframes and needs.
Using Excess Funds
After determining the optimal amount of cash that you should hold, consider what to do with excess money. Balance is key - having too much cash is unwise and can impact the success of your goals. Especially in our current environment, a well-designed investment strategy with customized asset allocation is key to short and long-term success.
Contact the Aevitas Wealth team. Let’s work together to determine your individual cash needs and identify the best cash management solutions to work with your customized investment and financial plan.