How much should I keep as a cash reserve?

by Reginald A.T. Armstrong, CPWA®

If there is one topic that just about every financial planner covers it is the necessity for every family to have an emergency cash reserve. This should rank way up there on the “must have” list.

What is a cash reserve? Essentially, it is rainy day money. Money to help you make ends meet when you lose your job or your income is disrupted for some reason.

So what makes up a cash reserve? For most families it should be…cash. Cash is liquid, relatively safe, and easy to access—all hallmarks of a cash reserve. Your bond, stock or housing investments, on the other hand, are not a cash reserve. For certain individuals, under certain circumstances, a line of credit or credit card can be responsible for a part of their cash reserve. But be careful here.

How do I determine how much to have as a cash reserve? At our firm, we use three guidelines to help clients decide how much to place in this bucket.

1. Two to six months of living expenses. Where a family is on this range depends on the certainty of the income, disparity of the income between the spouses, and how easy it is to replace the income. For example, a couple where one spouse earns $100,000 of commission income and the other earns $20,000 will likely need more “months” of cash reserves than a couple where both are teachers each earning $40,000.

2. Enough to pay for any known major expenses over the next two years. If that college tuition is due in three months, or you are going on a major vacation in 11 months, those funds should be in cash. These are known expenditures and the uncertainties of the markets dictate these funds should be in cash. The amount here is in addition to the amount determined in the first guideline.

3. Whatever makes you comfortable—up to a point. If the first two guidelines come up to $20,000 for a couple and it makes them more comfortable to have $30,000 in cash; that’s ok. Better to be slightly high in cash and comfortable than below their comfort level and a nervous wreck every time the market dips. However, keeping $130,000 would likely be too much.

As stated above, these are guidelines. Everyone’s situation will be different and for that reason prudent financial and possible tax advice from a trusted advisor should be sought.

*The opinions in this material are for general information only and are not intended to provide specific advice or recommendation for any individual.

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