Do You Have Enough Cash on Hand?
Whether you're working or retired, here's how to think about your liquid reserves.
The following is an excerpt from Christine Benz's recent webcast, Tune Up Your Portfolio in Uncertain Times. Watch the full webcast.
Christine Benz: The next step in the process is to evaluate the adequacy of liquid reserves. So, of your cash assets, the baseline for people who are working is three to six months' worth of assets set aside in liquid reserves. I think sometimes people are put off by how high those numbers seem--that seems like a lot of cash. And I think the issue is that you really want to think about how much you could get by on in a pinch, rather than thinking about how much you're spending today while you're employed. The idea is that you're building yourself an emergency cushion of the expenses that would be absolutely essential if for whatever reason you were not able to earn an income or if you were to become disabled, the idea is that you're building yourself an emergency buffer. For people who are retired, I like the idea of holding one to two years' of living expenses in cash investments. If you wanted to run with a lower cushion, you could potentially take that down to six months' worth of living expenses. But I think you would want to probably be a little closer to the one to two years' worth of living expenses.
A couple of things to think about with respect to liquid reserves. One is that if you've gone through this X-Ray process, you'll probably see that your cash weighting is higher than you thought it was. And that's especially true if you have active mutual funds in your portfolio. You don't want to take those residual cash balances into account when tallying up your emergency cushion. And the key reason is that you can't call your mutual fund and say, "Oh, equity fund, I would just like to pull out my cash holdings." It doesn't work that way, unfortunately. So, you'd want to look at the amount that you have that's truly liquid. And then, I think even though cash yields are very, very low today, it's also worthwhile just shopping around to make sure that you're getting the highest yield that you possibly can. And specifically, I think you want to be careful about some of the notoriously low-yielding cash accounts that are available, brokerage sweep accounts, for example. Even though they might be convenient, they're typically very low-yielding. If you are a little bit thoughtful and willing to do a little bit of homework, you can probably pick up a higher yield on your cash securities.
One thing that often comes up for retirees who want to maintain that cash cushion on an ongoing basis is, where to go for that cash, how to replenish that Bucket 1 or those cash reserves as they become depleted. So, if you're spending from that cash bucket on an ongoing basis, how to top it back up. And I think that there are a couple of ways to go about doing that. One is to simply take any organically generated income distributions, whether from your bond holdings or from your dividend-paying equities, and have those sent over into your cash account. That way your cash account is kind of topping itself up on an ongoing basis. So, even if you're not reaching for income, looking for income-rich stocks and bonds, you can still enjoy a little bit of income coming in the door through those income-producing securities. And then, if you need additional cash reserves, and many investors certainly will, because income is really low today, you can then use rebalancing annually to help top up the cash reserves. So, you would pull from the very appreciated portions of your portfolio and use them to top up your cash holdings. For investors who are looking back on 2021, which was generally another great year for the stock market, pulling from appreciated U.S. equity holdings seems like a really logical place to start if you need to rebalance and you need to top up your cash holdings.
How to Set and Invest Your Emergency Fund