Updated May 29, 2019
Deciding how much of your net worth to keep in cash is a huge part of managing risk while building wealth.
The simple formula to figure how much of your net worth should be in cash is the amount you need to cover all your monthly expenses multiplied by the number of months you want to cover.
But there is much more to consider in answering a critical question like how much of your assets should be in cash since not having enough cash can lead to huge financial problems and too much cash hinders the growth of your money.
In this post, we’ll first expand on the formula above, and then you’ll find the 11 important factors to estimate of how much of your net worth to keep in cash so you can pay your living expenses in both good times and the more difficult times.
I write this post from what I learned in almost 40 years personally investing and decades of juggling family finances and investments. I am also an Accredited Financial Counselor®.
Because of both the successes and mistakes from my real life investing experiences, I refuse to gloss over this important financial topic without addressing both risk and your ability to build wealth, so this post is long.
Everything here is important but you can use the table of contents to quickly find any section you want.
Cash Allocation in Portfolio Vs Cash Net Worth
This post is about how much of your net worth should be in cash. This is different but closely related to how much cash to keep in your investment portfolio because your net worth includes your home and other assets.
Both of these cash allocation topics are very important for managing your finances as well as managing risk while investing.
This post will focus on the percentage of net worth in cash as it relates to being able to cover all your monthly bills with ease, or in the event of job loss or an emergency.
How Is Net Worth Cash Invested?
Note that this post considers cash as funds in money market accounts or similar funds which are highly liquid, accessible immediately and don’t fluctuate in value at all.
While you may keep some money in cash not earning interest, most “cash” will be in some sort of mutual fund.
Why Having Enough Cash Is Crucial
You may have heard that you should invest all your money. But you’ll want a percent of your net worth in cash, so you’ll easily have funds to cover all the normal or unusual events listed below.
- Monthly Expenses
- Extraordinary Expenses
- Emergency Expenses
- Financial Crisis
- Job Loss
You’ll see some of the above expenses are normal and expected, such as monthly expenses and extraordinary expenses. But because these expenses are often overlooked or underestimated, so let’s keep them as part of the equation for estimating how much of your net worth to keep in cash.
The fact that we all need money to pay the utilities with ease every single month makes this an important part of the net worth equation.
Having normal expenses at the forefront also helps us stay attuned to the reality that the shopping trip really does affect our finances even though the purchase was probably made with plastic instead of cash.
I don’t know about you but I find it easy to loose that connection between my net worth and pulling out my plastic at the checkout counter.
Lifestyle Expenses Vs Emergency Funds
I like to call the first two expenses above, Monthly and Extraordinary, Lifestyle Expenses since they are a function of where and how you live.
The last three categories qualify as financial emergencies.
And you will almost certainly incur at least one of the more severe unexpected events listed above at least once in your life.
Jobs are lost, stock markets crash, divorces, and natural disasters all happen.
The reality is that:
- Job loss is a very common event.
- Bear markets and recessions usually happen once or twice every decade.
- The divorce rate is about 50%.
- And while natural disasters are less common, they happen.
For example, I have personally experienced a fire at my home and my mother in law’s home flooded.
Based on where you live, you can know if you should account for the unlikely event of a flood, hurricane or earthquake.
And certain industries are more prone to layoffs.
Realistically consider the likelihood of each of the unusual events above.
Hope for the best while knowing the worst does sometime happen.
Why Estimating the Percentage of Net Worth in Cash Is So Important
There are several reasons why estimating the right amount of your net worth to keep in cash is so important.
First, paying your bills with ease allows you to avoid financing costs and feel at peace about your money. No one wants financial stress, and there is no reason to have it.
By having enough of your net worth in cash, you’ll be able to get through financial crises, job losses and any other more severe situations. Not only this but knowing you can get through them will give you financial peace whether or not they ever happen.
And not having enough of your net worth in cash can lead to high debt costs, poor credit and even financial disaster.
Not only that, but your monthly living expenses are at the core of your retirement income planning. They tell you how much money you need to retire which sets the goal for wealth building.
Plus, having enough cash allows you to do the things in life that make you happy.
Another big reason for keeping the right amount of net worth in cash is that it will alleviate having to sell investments when it’s best not to sell them.
This is especially true when investments would need to be sold at a loss, or when selling an investment will trigger an undesirable capital gain tax at an already challenging time.
And, ideally, you’ll have some extra cash to invest when assets are cheaper following bear markets or recessions. This helps build wealth, as explained more below.
There are a few steps, so bear with me and keep reading, and then implementing.
The Equation for How Much of Your Net Worth Should Be in Cash
Let’s break the equation in the beginning of this article into more detail so you can calculate how much of your net worth to keep in cash so you can feel at peace about your money.
Monthly Living Expenses X Number of Months = How Much of Net Worth Should Be in Cash
Part 1 – Monthly Living Expenses
The first step is to get a number for your monthly expenses if you don’t have it.
Identify Where Money Flows Out
Knowing your monthly living expenses used to be simple. For the most part, money was spent via checks and cash.
Now, money flows out from many places, including automatic bank transfers, bank checks, investment account checks, wire transfers, various online apps, and multiple credit cards.
Recently I could only renew my library membership with a PayPal account. And I am setting up an app so my tenants can pay rent with it. My son wants me to set up another app for transferring money easier.
The number of places money can flow out is endless. Have you noticed that?
And the amount of places money can leave your possession will continue to multiply.
If this all sounds very granular and unimportant in relation to your net worth, remember that knowing how much money you spend each month is 1 of the 2 factors in knowing how much of your net worth should be in cash.
I like to think of our monthly incoming cash as being in a bucket. And every place money flows out is a leak in that bucket.
List all the holes in your bucket.
Total How Much Flowed Out of the Bucket
Once a month total how much money flowed out through each hole in the bucket.
Once a month is best to do this because you’re almost certain to catch expense mistakes before they happen again. If you can’t bear it, once a quarter is better than never, but you may miss important and big seasonal expenses.
I keep bucket holes to a minimum so it’s easier to track our spending. I like to download, copy and paste expenses into one spreadsheet. Then I simply total all the expenses.
You can set up an app for expense tracking or do what works for you.
Whichever method you choose, make a note of the fixed expenses and the expenses that you can easily lower because you’ll need this later.
This all sounds good, right? But it can lead to always feeling behind unless you take this next step.
At the bottom of my spreadsheet I quickly note any occasional expenses that were seasonal or extraordinary expenses. These are usually big expenses like the ones below.
- Income taxes
- Holiday spending
- Legal or CPA fees
- Property taxes
- New car purchases
Extraordinary expenses are usually expected but not monthly, making them different from Emergency expenses. For this reason, it’s easy to forget about them until they happen.
I also keep a tab with all the few extraordinary expenses for the year since these can ruin an otherwise perfect wealth plan.
Having them listed on a spreadsheet helps you be control of your money, which leads to more good wealth habits, which leads to more wealth.
Calculate your extraordinary expenses. Click the video below where I explain extraordinary expenses in more detail.
Add your normal monthly expenses to one twelfth of your annual extraordinary expenses.
Now you really know about how much it costs you to live each month based on your current lifestyle.
In taking these steps to decide how much of your net worth to keep in cash you have probably also found some money by reclaiming expenses, cut your expenses and gotten some clarity on your spending.
This is all excellent. Keep going.
Because knowing your finances and assets intimately will help you know the best amount of net worth to keep in cash better than anyone else.
Click here to read my post How Much Money Do You Need to Retire with more about tracking extraordinary expenses.
Part 2 – Decide How Many Months of Expenses to Have in Liquid Net Worth
Knowing your expenses was about gathering data while knowing how many months to keep in cash requires some insight and evaluation.
Most financial advice is to cover 3 months to 2 years living expenses, but I think you know your own situation better than anyone else. And you’re the one who will suffer if you’re wrong about the number of months to have in liquid assets.
Sometimes the problem with financial advice is that it often varies greatly based on who you ask, and what they are selling. Three months is very different from 2 years, right?
This means there is no set rule for everyone.
Below are the factors to use for evaluating what percentage of net worth should be in cash.
11 Factors Affecting How Much of Net Worth Should Be in Cash
There are many factors to consider in deciding how much of your net worth to keep in cash.
Having too much of your net worth in cash can hurt investment returns.
On the other hand, having too small a percentage of net worth in cash can lead to not being able to pay your bills.
So this is super important to your overall net worth and financial security.
1. How Much Is Your Net Worth?
Let’s face it. Someone with a net worth of $5,000,000 will probably need less cash than someone with a net worth of $500,000.
This is because high net worth individuals have a bigger asset base to rely on when financial challenges surface.
But the $5,000,000 net worth woman (or dude) may not have more in liquid assets, so keep reading. This is very important.
2. How Much Is Your Liquid Net Worth?
The amount of your net worth in liquid assets is a huge factor in determining your cash to net worth ratio. In this next step you’ll think about which assets in your net worth can be sold easily and quickly, and those assets that cannot.
Assets that can be sold easily and quickly are liquid assets. The amount you have in liquid assets has a huge influence on the percentage of net worth to keep in cash.
Investment Real Estate as a Percentage of Net Worth
Imagine someone with $3,000,000 net worth with almost all of it invested in real estate.
Real estate takes time to sell.
And the economic factors that affect how easy it is to sell real estate are often also the cause of personal financial problems.
This means when the economy is struggling, the markets in which your assets are invested, such as real estate (or stocks), usually fall hard.
Plus, real estate buyers become scarcer when the economy tanks across the board for several reasons. This often leaves real estate investors with their net worth tied up in assets that are not only not liquid, but that cannot be sold, period.
And the investor’s net worth has fallen due to the declining real estate (and other) investments.
These high net worth investors can become real estate rich but cash poor.
Home Values and Net Worth
The same scenario can be applied to home ownership. It affects how much of your net worth should be in cash and many people don’t realize it.
Imagine someone whose home has appreciated in value to $1,000,000.
This can easily happen over a decade or two of living in one home.
This situation would be similar to the real estate investor above, only worse, because selling a home involves time to find a new home and to move. It almost always involves getting new financing.
Taxes could be due, depending on the amount of the profit on the home.
Not only this, but real estate sales are highly seasonal in most places. Putting your home on the market in August will get usually an entirely different result than putting your home on the market in April during the spring selling season.
This seasonality may not coincide with your need for cash.
So having your home as a major portion of your net worth can lead to problems if you don’t have enough months worth of expenses covered in cash.
Click the video below to see if downsizing is right for you.
Investment Portfolio Cash Is Very Liquid
Stock and bond investors will need a lower percentage of cash net worth since these are very liquid assets.
While a stock investor will experience nasty bear markets when they happen, most stocks can be sold in less than a minute and you usually have access to your money within 3 days.
Note that stock mutual funds usually sell at the end of the business day and take 1 to 3 days to get your money. ETF’s (Exchange Traded Funds) and individual stocks can be sold while the stock market is open but it takes 3 days to get your money.
Bonds usually have the same access time when held in funds.
In other words, net worth will decline for stock investors during bear markets, but the money invested in stocks is easily accessible.
For this reason, it’s important to update your net worth often noting how liquid your net worth is at any given time.
3. Cash Allocation in Portfolio Affect Cash to Net Worth Ratio
After you clarify how much of your net worth is in liquid assets (stocks and bonds) as explained above, next, see how much cash is in your investment portfolio.
This is because you have to consider portfolio cash when deciding how much of your net worth should be in cash.
Almost all traditional investment portfolios have assets allocated (divided) among stocks, bonds and cash.
Click here to read my post How to Understand Your Investments where I explain more about asset allocation in cash, stocks and bonds.
Again, cash refers to money market or similar funds that do not fluctuate in value. In other words, the value should always equal $1 in cash type of investments.
Net Worth Cash Ratio Vs Ratio of Cash to Investments
The cash allocation in your portfolio is very related to the percentage of net worth to cash, but different since your net worth includes home equity and other assets.
While the two are different, think of them as one big picture since you can probably tap into your investment cash should you need it for expenses or financial emergencies.
But also remember that some of your investment cash may be tied up in IRAs or retirement portfolios that cannot be used without a penalty of some sort.
This is another reason these two topics (net worth cash and portfolio cash) are related but also separate. It depends on your own situation.
Factors Affecting the Cash Allocation in Your Portfolio
A. Portfolio Cash Allocation Based on Age
Based on traditional investing models using standard asset allocation, older investors tend to have a higher level of cash in their portfolio to lower risk.
On the other hand, younger investors tend to have a higher level of cash in their portfolio.
B. Proactive Cash Allocation in Portfolio
Note that if you work with a more tactical financial advisor that considers market valuations and cycles in determining how to allocate your money among cash, stocks and bonds, or if you are a more proactive investor yourself, you likely have more of your portfolio in cash as markets become riskier (overvalued).
This can be very valuable in reducing risk since financial problems are more likely to arise during recessions and bear markets. And risky times like this are when you need more emergency cash.
C. Cash to Buy Undervalued Assets
Keep in mind that if you have a higher percentage of net worth in cash, after bear markets and recessions you can buy assets cheaply.
For example, a blue chip stock which may have cost $100 before a bear market may cost $50 or $60 after a bear market assuming history repeats itself.
Unless there has been a major fundamental change at the company, it’s the same blue chip stock, only much cheaper.
There is also a lot of uncertainty, and usually a recession causing real estate prices to decline.
The price tag of a rental property or home could be cut in half or more after real estate plunges as it does every decade or two. I’ve noticed that real estate also gets cheaper when stock bear markets occur every decade or two because the net worth of real estate buyers declines.
This can also be a great time to buy a vacation home that can be a vacation or Airbnb rental, also if you want the extra income.
So, having a higher level of cash after bear stock markets or real estate plunges can change your entire financial situation for the better.
Now let’s get back to other factors affecting how much of your net worth should be in cash.
4. Asset Protection Lowers Cash to Net Worth Ratio
Lawsuits, which are usually impossible to foresee create unanticipated risk to net worth. Look at your life to consider if you may need to increase cash for this potential liability.
You may want to talk with an insurance expert (while keeping in mind that they probably sell insurance and could suggest that you need more insurance than you do).
Most lawsuit risk can be mitigated with insurance usually making it worth the expense. And while it will increase expenses, insurance will reduce the percentage of net worth you need in cash.
5. Overlooked Liabilities Increase the Percent of Net Worth Cash
Make sure there are no overlooked liabilities that would increase the percentage of net worth to keep in cash.
Are there any liabilities you may have overlooked? Taxes are commonly underestimated, especially for entrepreneurs.
Does cyber security hold risk for you?
Could your line of work present any unforeseen liabilities?
6. Health Issues Increase the Amount of Net Worth to Keep in Cash
While many health problems can’t be anticipated, many can. Consider if you have potential health issues that could lead to you being unemployed or incurring expensive health care costs.
If so, you’ll want to adjust your cash to net worth ratio accordingly.
7. Amount of Fixed Expenses Vs Variable Expenses
You distinguished between fixed vs variable expenses earlier. Some of your expenses could be cut quickly and easily if needed, such as shopping sprees for things you don’t really need and dining out.
On the other hand, fixed expenses like the mortgage, utilities and insurance don’t have much wriggle room without making bigger lifestyle changes.
Identify your fixed expenses and total them. The bigger fixed expenses are, the higher your cash as a percent of net worth will need to be.
8. Number of Dependents Raise the Percentage of Cash You’ll Want
Young or adult children that are in a financial bind, aging parents, or other dependents can increase the amount of net worth you’ll want in cash.
This topic is a big conversation beyond this post. It’s a factor that many investors over 50 are experiencing in their retirement planning, sometimes at both ends, with both parents and young adult children needing financial help just to live.
9. More Income Earners Lowers the Percentage of Net Worth Cash
The risk from potential job loss can be lowered by having more than one income earner in your home.
For every additional income earner you’ll need less of your net worth in cash.
Another way to lower the risk from job loss is for either you or another income contributor to have highly marketable skills that can be used to increase income immediately if needed.
Examples include social media marketing, content marketing, video creation or editing, graphic design, and consulting, to name only a few.
10. Income Streams Can Lower the Percentage of Net Worth in Cash
The more sustainable income streams you have, the less the percent of net worth you’ll need in cash since you’re more likely to be able to cover living expenses from diversified income sources.
In your cash to net worth income evaluation, consider passive income from investments, such as dividends and interest.
But note that unless you’re in retirement, you’re probably reinvesting investment income.
In this case, when you’re evaluating how much of your net worth to keep in cash, you may decide to temporarily tap into investment income as a solution should the need arise.
In other words, it’s there if you must use it but better if you don’t.
Alternative Income Streams
Or you may have alternative income streams, such as real estate rentals, Airbnb, or small business income.
Online Business Income
Online income is becoming a staple income source for more people every day with the ease of creating websites and the multitude of ways to drive traffic to them from both ads and social media.
Or click here to read about all the different types of online businesses and if it’s too late to start an online business.
I include the importance of alternative income streams is as I have learned firsthand that it works. We have completely replaced job income with alternative income streams over the past 15 years after stumbling upon an early retirement.
11. Debt for Home Vs Lifestyle Spending Affects Net Worth Cash Needs
The amount of debt you have will affect how much of your net worth should be in cash for several reasons.
I do think there is good debt and bad debt. But in general, the more debt you have, the more net worth you’ll want in cash for several reasons.
First, if you get in a pinch, you can borrow money until you’re back on solid financial ground. If you already have high levels of debt, it will be harder for you to borrow money should the need arise.
Second, the more debt you have, the more fixed expenses you’ll have.
Third, if you have consumer debt, you’ll be spending more every month on, basically, nothing. While real estate debt could be helping you purchase an asset with the potential to increase in value over time, or even generate income, consumer debt has a zero chance of a potential positive outcome.
Summary for Net Worth to Cash Allocation
All above factors affect how much of your net worth should be in cash.
The bottom line is that the amount of your net worth that should be in cash is the amount you’ll need to feel financially secure while allowing you to maximize wealth building.
And when you make this determination, you have taken a huge step toward financial independence through leadership of your wealth.
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Disclaimer – This article is for educational purposes only and is not in any way meant to be taken as financial advise. Do your own math and research. Take responsibility for your own money. Lead Your Wealth.