How much cash should I hold in retirement?
Most of us are familiar with the idea of having an “emergency fund” that can help with unanticipated expenses or in the event you need cash to pay bills in the event that you lose your job. Unemployment is no longer a risk for most retirees, but a prolonged bear market could be. As such, holding a cash reserve in later life as an insurance policy is often recommended as a way to pay your bills without having to sell investments when markets drop.
This might sound simple, but there are a wide variety of opinions on this topic and, in my opinion, no single, correct answer.
Some experts question whether retirees need a cash reserve at all. For folks in this camp, the thinking is that if you need money for an emergency, then just tap your retirement savings. The rationale here is because the low returns on a certificate of deposit or a money-market fund are a drag on your nest egg’s overall performance.
We have a client, for example, who has been keeping a cash allocation in his since portfolio we started working together in 2004. He’s never tapped into it so far and, on a whim, we calculated the cost (the “cash drag”) to his portfolio at $90,000 as of last month. This figure is close to the amount of cash he kept aside, to begin with.
For those who do favor holding a cash reserve, most still can’t seem to agree on just how much money to set aside. One year of living expenses? Two years? More? There is no right answer simply because no one knows how long the next bear market will last. Just like there is no way to accurately anticipate all of the stock market volatility we may experience over the course of a 30-40 year retirement, there really is no way to perfectly quantify how much cash to keep on the sidelines.
As I wrote two years ago (“Cash Can Buy Happiness”), keeping cash on the sidelines in retirement isn’t so much a financial decision as it is an emotional decision. Deciding how much cash to keep on hand is similar to deciding how much risk to take with your portfolio. Most people (and many financial advisers) like the idea of a cash reserve simply because of the “comfort” factor, knowing you have cash on hand if the sky falls. In this sense, I agree that it makes sense to keep some cash aside for a couple of reasons.
First, if the cash you keep aside provides peace of mind and allows you to sleep at night and actually enjoy your retirement, then this is incredibly valuable. We know that the key to long term investment success is to stay invested. So, secondly, if the amount of cash you set aside allows you to keep the rest of your nest egg invested through the ups and downs in the markets that will occur during retirement, then this is also incredibly valuable.
Keeping a cash reserve that amounts to, say, a year of living expenses might not be the worst idea. If markets tank, that amount of time may allow for thoughtful planning—the opportunity, perhaps, to realize losses on some investments, offset gains on others and rebalance the overall portfolio. But again, a year may or may not be the “right” number. More often than not, the right number is a “personal preference” and this is what I experience in working with different people every day. We need to discuss in order to help get you to the right spot where you feel comfortable.
As for those just starting retirement, you’ve probably heard that you may want to be a bit more cautious initially. The primary reason: “sequence of returns” risk. This is the risk of getting hit with negative market returns early in retirement. If the value of your savings is falling and if, at the same time, you’re withdrawing funds from those savings, that double whammy can deplete your nest egg in a hurry.
Of course, if you’re only withdrawing the “yield” from your retirement portfolio (just the interest and dividends) and not actually dipping into the “principal”, then this risk can be overstated. And if you have your retirement portfolio designed to satisfy your withdrawal needs and you still have the cash to spare, then this is ideal.
Regardless of your situation, for those about to pull the trigger, a good rule of thumb is to know exactly where your income is coming from for the first three years of retirement. Understanding what you need and what you might have to spare as well where your income is coming from in those first three years is important. It’s why we initially prepare a cash flow projection for you and/or review it with you periodically.
A cash flow projection is an important and valuable exercise that we offer as part of the service of being an ACM Wealth client. It provides you with clarity on what you need your assets to do for you in retirement, and thus how they should be invested. Knowing this can help give us both a better perspective on how much cash to keep on hand as well as peace of mind knowing that you have a plan in place.
If we haven’t done a cash flow projection this with you yet or it’s been a while since we’ve last reviewed it, then reach out to your ACM Wealth Advisor who will be happy to assist.
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