So how much cash is enough for you and your financial plan?  I’m referring to your short-term reserves, emergency fund, and perhaps a future fun account.  We covered why you need cash, how to segment it based on purpose, and its impact on your financial plan here.  How do you quantify an accurate amount of cash, so you are not holding too much or too little?

Often the level of cash you hold is a personal choice.  Likely, at some point in your life, you have experienced different levels of available cash.  At times, too much, while at other moments too little to meet short term expenses or needs.  All of these unexpected events can leave a lasting impact on you, your emotions, and your tendency to hold a certain level of cash.  It’s in these experiences where you felt comfortable, stressed, or relaxed that defines where you and where your cash levels need to be.  These life events at various ages will impact you and your relationship with cash, what other factors should be considered?

      • The steadiness of your income (and employment) is a huge consideration as to how much cash you should be holding for unexpected expenses. Your income and frequency of compensation matters.  Are you taking a monthly draw with an anticipated bonus or distribution later in the year?  Is some of your compensation tied to company stock, performance-related, or in the form of other non-cash compensation?  Are you generating income via commissions and sales or do you receive a steady paycheck each month?  If you are retired, how much of your monthly retirement income is fixed via a company or government pension and Social Security?  Does your cashflow include a spouse or significant other’s income source as well?  Recognizing the frequency and amount you are paid each month is the first step in determining your cash needs.
      • Do you rely on a home equity line of credit (HELOC) to meet your short-term liquidity needs? This can be helpful if used responsibility, in conjunction with traditional cash reserves.  Of course, there are external factors to consider when using a HELOC.  During the 2008 financial crisis, when liquidity was scarce or simply unknown, the first thing many banks did was freeze or close home equity lines of credit.  If a home line of credit is part of your cash reserve system, have you considered what you may do (or not) should the terms be changed by your bank?
      • At what stage in life are you in right now? Are you currently working and accumulating wealth, distributing your wealth in the form of income, a combination of both, or somewhere in between?  Early to midway through your career you may have a number of increased fixed expenses around your family, children, and the home you live in.  All of these events may lead you to hold more cash to cover these increasing expenses.  Mid to late in your career you may have paid down a significant portion of your mortgage, the children are hopefully living independently, and you may likely have fewer revolving expenses.  Where you are now, and your monthly fixed expenses may help guide the amount of cash to hold.


How might you quantify enough cash and its role in your financial plumbing system?

      • Take a look at your fixed monthly essential expenses, the ones that need to be paid, each and every month. Items such as housing costs, medical insurance, utilities, groceries, may come to mind.  Are there other unique expenses you need to factor in as well?  Is a family member dependent on you for income?  Add this amount in to determine your essential monthly expenses.
      • Now take those total expenses and multiply it by three, this represents three months of essential expenses. How do feel about this number?  Do you have enough cash to cover these essential expenses?  Now multiply your number by six, are you feeling better or does this feel like an excessive amount to cash to hold?  Now multiple by twelve, how do you feel now?  There are no right or wrong answers in the amount of cash you need to hold.  Large one-time big-ticket expenses may also influence how much cash you hold.  Having these dollars set aside in a separate account assists in managing your reserves and avoids lumping all of your cash together.  It’s important to give yourself time to reflect on this exercise to determine your comfort level and the correct amount of cash reserves for YOU.


Having a firm grip on how much cash you choose to hold in reserves is an important part of the financial planning process.  Of course, it’s not always just about you, often a significant other or spouse has an opinion on the matter, which may complement (or conflict) with your approach to cash.  This is where good communication pays off.  Remember, each of us is unique and it’s our personal experience that defines how much cash we feel is necessary.

Determining cash levels is more art than science.  It’s absolutely critical this conversation takes place as part of your approach to planning and review each year.  Having this conversation BEFORE you begin investing ensures you have proactively set the correct cash aside and will be less inclined to react to investment results or life events.  Continuing to discuss and manage cash, while reviewing your investments annually, really does matter.  Based on a number of factors, your cash reserve comfort may increase or decrease over time, based on your priorities and goals.  Figuring this out, in a relaxed manner, before emergencies arise, is a critical step in the financial planning process.


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