How much cash should you keep?
Inspired by a number of recent reader questions, I thought I would chime in on this subject: how much cash should you keep including our plans for the future when it comes to cash.
Reader questions (adapted only slightly for the post)
In a recent weekend reading the following quote caught my eye: “The only time you should be worried about a correction is if you need the money within the next five years and haven’t made an appropriate plan to access the cash.”
What did you mean by that?
I am 68 years old and my portfolio has done quite well during the last year. I feel however there is going to be a major market correction (cause unknown at this point) and would like to put a plan in place to access the recent growth (still within my RRSP). I have raised this with my financial advisor who says to stay invested (modest growth profile) however I don’t feel I have a plan in place that addresses my needs in the next 1-5 years.
Overall I am happy with my financial advisor’s advice but feel that changes are needed.
Related to the email above…
You might be on holidays – and if so, I hope you ignore this email until your return. (Mark – I didn’t!)
I just wanted to check in to see if you know when you might cover this. In particular I’m keen on better understanding a “plan” to access the recent growth I’ve had in my RRSP as I don’t think I have the timeline to go through another 2008 type of recovery to my portfolio. I am thinking about it as a “fold and hold” strategy. I think I would sleep better although my advisor wants me to stay fully invested – however I think this might be to his advantage rather than mine.
I know you have talked about having a cash fund to cover 1 years’ worth of expenses. At the same time you mention the importance of being invested. Is that conflicting a bit?
What I mean is, our rule of thumb is $30k invested, creates $1k of dividend income. So you can quickly figure out how much you need invested to cover your yearly costs.
Back in our student days, we tried to keep a cash balance of $500. That slowly went up to $1k. Now, years later, that fund tends to float around the $5,000 mark. Having two kids, it is amazing how much money flows in and out of the chequing account each month! Stunning really, if you went back in time and told your 10 year old self how much money you would have filter through your hands each month. Damn!
I can see the rationale for wanting a cash safety net, but when do you build it up? And by the time you might build one, you should at that point already have a solid stream of income that covers your expenses. See my rule of thumb above.
Once you punch through to the double coma world, or double dot if you’re European, you might find you don’t need as much cash on hand since the portfolio delivers everything you readily need.
The monthly income growth via dripping takes a life of its own…
I know some of your readers think this way already, which is ideal, since the best thing we did was track income from the beginning. Yes, the capital amount is nice to observe, but that isn’t what we plan to have paying the bills.
The summary: when the income from your portfolio delivers what you need and then some you don’t need as much cash on hand as you think.
Great stuff readers!
A few things to unpack above so I’ll try and tackle various questions and comments in the order they appear above.
First, good on the first reader to take more ownership over their money. To clarify though, that quote was from Boomer & Echo’s site from my post. That said, I do happen to agree with Robb who runs that site with a few clarifications on my end/my perspective:
1. I think any money you absolutely need/absolutely depend on in the next 1-2 years should likely be in cash or some form of fixed income. Cash could be while you’re saving for a house when younger (i.e., you really need that down payment) or cash that is potentially set aside during retirement. I say this for the latter because who knows what the future holds and I think any combination of a basic emergency fund + cash on hand to combat at least a 12-month major market calamity or other should be readily accessible. Cash should be there when you need it or least expect to need it. I just think that’s smart planning.
Other than a few occasions where we dipped into this account, we keep our emergency fund at this level. That money is in a savings account, earning interest, slowly growing the emergency fund over time.
2. I think most people should have a cash/emergency fund. $hit will happen and I think the last thing you want in any financial emergency is more debt. What that emergency fund must be for you, is hard to mandate. I would say however having at least a few weeks if not a few months of basic expenses to be covered by your emergency fund is very smart planning.
Our cash fund plan in the coming years…
Check out the post but the graphic below is our current thinking:
Creating some form of “bucket approach” for your retirement income stream might work well for you.
Your financial advisor might not be wrong…
“I would sleep better although my advisor wants me to stay fully invested – however I think this might be to his advantage rather than mine.”
He/she might not be wrong!
I think any money you might need in years 3-5 should likely be maintained in some form of fixed income and/or in the form of assets that should deliver dependable income. I believe the worst thing you can likely do in any potential market meltdown is sell lots of equities. You do need to stay invested.
So, that means you need to consider a blend of bonds and stocks (equities) that you don’t panic sell when things get rough. Rather, use of mix of bonds and stocks to stick to a withdrawal plan that mitigates portfolio ruin in retirement.
Some argue the “4% rule” is a good rule of thumb. Others will strongly disagree for some good reasons.
Maybe this is a subject you can discuss with your financial advisor. The mix of bonds and stocks to deliver a sensible, variable percentage withdraw plan for your portfolio.
Here are some other posts on my site to help you and others out on that subject:
I know some readers on this site use the VPW approach for their portfolio draw down approach to a great success. I would further state if your financial advisor does not know about this approach, it might be time to find a new advisor!
Is 1-years’ worth in cash too much?
“I know you have talked about having a cash fund to cover 1 years’ worth of expenses. At the same time you mention the importance of being invested. Is that conflicting a bit?”
Great pointed question but I don’t see it that way.
I feel, rightly or wrongly at this point, having ~ $50,000 in cash to cover any emergency when I’m no longer working full-time is likely “enough”.
Any more cash savings than 2-years’ worth of expenses is likely a big loser to inflation alone.
Will I change my mind about my 1-year fund when I actually hit semi-retirement in a few years? Maybe!
For now, I feel this cash-level is an appropriate balance between riding out any long-term emergency and/or living through a poor 12-month stock market term while staying invested like I touted above. This will allow my portfolio do most of the work in any market condition via dividend payments along with distributions.
When should I build up my cash wedge?
“I can see the rationale for wanting a cash safety net, but when do you build it up? And by the time you might build one, you should at that point already have a solid stream of income that covers your expenses.”
Honestly, hard to say. I hope you are correct of course. Having a solid income stream is our goal and has been one to start semi-retirement with for many years now.
We listed our 2020 financial goals here but increasing our cash wedge to help prepare for semi-retirement didn’t make the cut.
Given we believe we’re about 5 years (or so) away from some decision-making to begin semi-retirement, it’s probably wise to start building this cash fund in the coming years. With $10,000 already in the bank, I figure we have less than $40k to go. That’s saving just shy of $10k per year towards this fund or roughly $800 per month.
Of course, we might not need to save even that much money because money that makes some money (via interest) can make more money on its own.
In 2021 I suspect we’ll consider diverting any savings towards increasing our cash fund to start semi-retirement with since both TFSAs and RRSPs should be fully funded early that year. We should have some leftover money to save when we’re no longer saving for retirement any longer. Hard to believe those days are coming!!
The only anchor we’ll have to overcome to declare financial independence with is some small mortgage debt that’s slowly being killed with accelerated bi-weekly payments right now.
I have found “the monthly income growth via dripping takes a life of its own”.
Indeed good reader!
It’s quite remarkable to see my portfolio on autopilot actually. With dozens of stocks DRIPping I can now see the compounding power right in front of my eyes every month – hundreds of stock shares buy a handful of more shares commission-free. The same thing happens next quarter. And the next…
Then there are the dividend increases…
With various companies we own in my taxable account and our tax-free accounts (thanks TFSA!) churning out more dividends coupled with dividend increases (already this year), we’re really starting to accelerate towards our dream-like goal of earning $30,000 per year from just these three accounts.
That income will pay for many of our basic living expenses – for life.
“Once you punch through to the double coma world, or double dot if you’re European, you might find you don’t need as much cash on hand since the portfolio delivers everything you readily need.”
I hope to write about our journey and realization at achieving and passing the double-comma club soon.
Readers, what do you make of having any sort of cash wedge in semi-retirement or retirement?
How much cash should you keep? What do you keep and why?
Do you believe my goal of keeping $50,000 in an interest savings account while I live off dividends and distributions is enough or too much?
Other perspectives? Happy to read them in a comment below! Share your thoughts so others can learn…