What’s Your Cash Comfort Level?
Lisa Dieter, 22 Aug 2017
As wealth-management advisors, we’re continually asked this burning question: How big should my financial security blanket be – how much money should I have in the bank? What’s definitely too little? How much is too much?
The boilerplate answer is 3-6 months of living expenses or net pay, and that’s a good ballpark for most people. But the truth is, there’s much more to consider – key factors that might mean you need more or less(!) in your savings account.
Learn the real costs of having the wrong-sized security blanket, and how to find your just-right cash comfort level.
Cash sitting in savings is likely earning less than 0.5% a year. So if you could be earning, say, 6% per year invested, then you’re losing a theoretical 5.5%. Real numbers? If you’ve got $50K in excess cash, then you’re missing out on $230/month extra income.
Most people with excessive cash reserves know it’s an issue and feel embarrassed about it – not only do they not know exactly how much they should have, but they also seem unable to fix the problem. When the stock market is up, they regret not investing, and when the market falls, they fret about whether it’s time to invest. Even when the market stays flat, they’re worrying whether they should be shopping interest rates or looking for better fixed-return products.
It’s way easier to make a large impulse purchase [couch, car, Cabo, etc.] when you’ve got a pile of extra cash sitting around. There’s nothing wrong with spending your money, but if you want it to contribute to your contentment, then a little mindfulness goes a long way. Keeping only the necessary amount in the bank limits your ability to make large purchases on a whim.
It may be harder for you to turn down loan requests from family or friends when you’ve got excess cash. If your grandchildren are hinting around about help with a down-payment for a home, it may be easier to say “sorry” if offering them the cash would result in a large taxable event or upset your long-term investment plan.
In my experience, people who feel “stuck” about how much cash to have on-hand tend to be stuck in other life decisions as well. I’ve found that a simple, straightforward conversation about their cash reserves can often create an “aha!” moment and a framework for forward movement in all arenas.
Most people with excessive savings continue to accumulate more and more, because whatever got them to that spot is still happening. So whatever consequences are already underway will, at best, continue – but, much more likely, they will worsen over time.
If you don’t have enough accessible cash to meet some unexpected expenses, then you might use credit cards, putting you close to your limit, which negatively affects your credit – and your lower score may mean you pay more on a subsequent mortgage or other major loan.
The moment when you suddenly need a load of cash is typically a stressful moment, anyway – a deal went south, you’ve lost your job, someone has become ill, a death has happened, a significant home repair has become necessary, etc. It’s not the moment you want to feel strapped for cash, too. Being prepared financially will mean one less worry in a time of chaos.
A recent UK study found that people with higher liquid wealth possessed more positive perceptions of their financial wellbeing, and subsequently, higher satisfaction with their life. This correlation persisted across multiple controls, including investments, spending, indebtedness and demographics – suggesting that having enough cash reserves can contribute to overall happiness.
Money can’t buy happiness, but it can provide choices. People without the security of sufficient savings can feel trapped in their current job, marriage, house, etc. Many of my clients have made quantum leaps in their careers once they felt they had a strong financial safety net to back them up.
Your cash comfort level is somewhere between the extremes of “not enough” and “too much” – and it’s been my experience that the right balance varies vastly from person to person. Here are some key questions I urge clients to consider as they’re determining how much they need in the bank:
How likely is it that the income stream from your job or your partner’s job will suddenly stop? A tenured university professor will answer quite differently than a luxury homebuilder – higher security means less savings necessary; lower security means more savings needed.
How easy is it for you to replace a lost income? Maybe your job isn’t all that secure, but you can easily get a comparable position paying a comparable salary … or maybe what you do is fairly rare, and getting a new gig might take a year or two.
Our life experiences shape how we think and feel about money. Someone who grew up with little money and relentless stress because of it might need more cash on-hand just to feel comfortable, while a natural risk-taker might prefer having less idle cash because they worry about the opportunities they may be losing out on.
What other investments or assets do you have that can be used or sold in case of emergency? Maybe you’ve got an investment portfolio that could be tapped, or a classic car collection you would be willing to part with. If not, then you should make sure your cash reserves are plentiful.
Do you have upcoming events or approaching commitments you know you’ll need cash for? One of your kids just got engaged, a parent is in declining health, you’ll need a new car in the next couple of years? Be sure to consider all that as you determine your cash comfort level.