It was 1979 and I felt like the famous outlaw Jesse James.
I was an undergrad at Carlton College in Minnesota. Our town, Northfield, had one claim to fame. In 1876, it became the only town to resist bank robber Jesse James and his gang. To this day, the city reenacts the failed robbery outside of the First National Bank each year.
A hundred years later, banks faced a different kind of problem. The country was in a recession. Inflation ravaged the financial markets, unemployment soared, and the oil crisis took hold.
None of that bothered me. I was just a student. However, I saw opportunity in the Fed’s sky-high interest rates.
Each semester, I took my funds, deposited them in the bank, and collected 22% in interest. Then, at the last day possible, I’d withdraw the funds and pay my bills. It was the easiest cash I’d ever made. I felt like a regular bank robber.
Unfortunately, many “completely safe” places to park your cash (like a bank) aren’t really safe anymore… So where is the best place to put your cash? And how do you manage it?
No one likes to talk about cash management. But in the coming months, we’ll break down the basics of cash allocation for you.
Today we’re going to start with the first question in cash management: How much?
By cash, we don’t mean actual dollar bills stacked up in your sock drawer. We mean money you can access quickly, with no loss of capital and few transaction fees.
This includes checking accounts, savings accounts, and a few short-term investment accounts we’ll get to later.
Basically, cash is the money you can use to pay for things with no worries or hassle.
With that in mind, when we talk about how much cash you need to hold, we’re really talking about two different things:
- Your emergency fund.
- The cash allocation of your portfolio.
Your emergency cash fund is there to provide a safety cushion in the event of unforeseen emergencies, especially the loss of your source of income.
In many ways, how much is a personal question. It depends on how safe you want to be. You can find experts saying that you should have between three and 36 months of living expenses in your emergency fund. I’d narrow that range to between six and 12 months.
To measure where you fall in that range, think about the risks that affect your life…
If your job is in a cyclical industry, you need more savings than someone whose job is recession-proof. If you only have one income-earner in the family, you need more than if you have two. If you have a large mortgage payment, you should keep more on hand than if you rent an apartment, since missing mortgage payments is more painful than skipping out on rent.
It also depends on how nervous a person you are. You should keep enough cash to sleep well at night. That’s the central tenet to all of my investment advice.
Another thing to remember, six to 12 months of expenses is a lot of money for nearly anyone. For those just starting to save, it seems like an insurmountable number. Don’t be discouraged. Three months of expenses saved is better than two months. And two months is better than no months.
A small cushion is better than none at all.
After you’ve got your cushion, you have to look at the longer-term cash allocation in your portfolio.
For a young person with 30 years to retirement, there is little reason to have any cash holdings in your portfolio, after you set aside your emergency fund.
As you get closer to retirement, you should start moving some of your investments over to cash. You should start this phase five or 10 years before retirement. And you could gradually grow your cash allocation from, say, 5% to as high as 20%, depending on your goals.
When figuring out how to scale into this cash amount, you need to think about the safety cash provides, and the hidden risk cash carries with it.
For example, one of the downsides of cash is interest rates. Falling rates means you’ll lose value on your money. But with rates set to rise later this year, now’s a good time to start planning your cash strategy.
I’ve outlined the best ways to hold cash in my newsletter Income Intelligence. If you’re already a subscriber, you can read my recommendations right here. If you aren’t a subscriber yet, joining is easy. Click here to learn more.
- Something different: Your coffeemaker is watching you.