Now more than ever, we often find investors asking themselves the question, what is the appropriate amount of cash to set aside as “reserve?” Spending any amount of time contemplating this topic, you quickly find out how vexing of a question it is. While it’s always a good idea to have some emergency cash, too much or too little in this interest rate environment can be a costly mistake. While there is no perfect calculation or answer, there are tools available to begin the dialogue on what makes sense for you.
Sleeping well at night
First and foremost, a cash reserve for most families serves as a psychological safety net. Knowing that there is a certain amount of cash available lets us sleep well at night knowing we can be ready for whatever curveball life may throw. Historically, the “3-6 months” of living expenses guideline has served as the golden rule. While a helpful conversation starter, this is not a sufficient answer for most. Deciding on the right amount of cash reserve should be a purpose driven process.
Finding your baseline
Where to start? We recommend taking some time to look under the hood at your monthly expenses. While there are seasons of life and changes to expenditures that go along with them, it’s important to identify your basic core expenses: health insurance, mortgage, food, and utilities to name a few. Focus on the “needs” rather than the “wants.” Once this number is determined it is important to open a dialogue with your advisor to better understand whether 3, 6, or even 12 months of core expenses is the right reserve needed for you.
Determining your buckets
Taking the time to create a cash reserve often enhances long-term investment outcomes. Once an emergency fund is established it is important to be consistent in keeping that baseline amount. This allows the financial freedom to take on the necessary investment risk for your long-term goals.
- Immediate Bucket: Cash that is available in a moment’s notice. Earning interest in the bucket is appealing, but the focus should be simple access for short-term and unexpected cash needs.
- Lifestyle Bucket: Income assets that are generated for your intermediate term spending needs and help keep pace with inflation. This bucket can range from funding your ongoing retirement, to large, anticipated cash expenditures such as a car purchase or new roof. This bucket is there to accomplish your high priority cash flow needs over the next 1- 5 years.
- Growth & Legacy Bucket: Long-term growth assets that are designated to grow more than inflation. These assets have a higher risk/return strategy that allows you to refill your immediate and lifestyle buckets and potentially create long-term wealth to transfer to family or charities during your lifetime.
Taking the time to determine and establish your cash reserve fund is an important step in establishing your financial “buckets.” Understanding what you need to have available to sleep well at night will provide the clarity necessary to help you build an efficient and purposeful portfolio.