We know it’s important to have cash available for our everyday spending needs as well as the inevitable “rainy day.” While it may seem like a good problem to have, having too much of your savings sitting in cash can be an issue, especially when you are investing for long-term goals such as retirement.
4 uses of cash
To help you determine how much cash makes sense for your situation, we use the acronym “USES”:
- Unexpected expenses and emergencies – cash used for situations such as a job loss, a home repair or an unplanned medical expenseHow much? In general, we recommend about three to six months’ worth of living expenses
- Specific short-term savings goal – cash dedicated for a goal that will occur within the next year or so, such as a wedding or vacationHow much? The amount would be based on the goal.
- Everyday spending – cash used to provide for your lifestyle, including day-to-day spending needs such as groceries, utilities, entertainment and your mortgage/debt paymentsHow much? If you’re retired, we recommend about a year’s worth of income needs from your portfolio in cash. If you’re still working, we recommend about one to two months’ worth of living expenses in cash, refreshed by your paycheck.
- Source of investment – cash used as an asset class and as a source for investment opportunitiesHow much? In general, we recommend up to 10% of your fixed income in cash, which would be approximately 5% of your overall portfolio.
The risk of not investing
Some people hold too much in cash, viewing it as a safe haven against the risk of a market decline. But cash is not risk-free: If it’s designated for a long-term goal such as retirement or education, the biggest risk you face isn’t a temporary pullback in the market – it’s the possibility of not reaching your goal.
By ensuring you have each of the USES areas covered, you can better focus on your longer-term goals, including preparing for retirement and paying for education. Schedule some time now with your financial advisor to review your USES of cash.
Article written by Scott Thoma, CFA, CFP, Principal for Edward Jones