Deciding how much of your net worth to keep in cash is a huge part of managing risk while building wealth, as well as contributing to a peaceful existence.
The simple formula to figure how much of your net worth should be in cash is the amount you need to cover all your living expenses multiplied by the number of months you want to cover. Most investors want to cover between six to twenty-four months worth of expenses.
In this post, we’ll first expand on the formula above.
Then you’ll find 10 important factors to estimate how much of your net worth to keep in cash so you can pay your living expenses in both good times and bad, while also allocating enough net worth to investing.
I write this post from what I’ve learned in almost 40 years of personally investing and decades of juggling family finances and investments, as well as my Accredited Financial Counselor® credential, financial coaching, and also an accounting career in a prior life.
Because of both the successes and challenges from my own experiences in deciding how much of my net worth should be in cash, I refuse to gloss over this important question without addressing both risks as well as the importance of investing, so this post is long.
As much as I love to give simple, one size fits all answers, your financial security is too important for that. Therefore, decide how much of your net worth to keep in cash based on your own situation regarding each of the factors below.
After all, it’s your money and your financial security at risk if you get this wrong. 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 will focus on how much net worth should be 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.
Note that this is different but closely related to how much cash to keep in your investment portfolio.
Both of these cash allocation applications are very important for managing your finances as well as reducing investment risk while building wealth as taught in my How to Retire When You Want course.
Let’s Define Net Worth Cash First
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. Cash is also money on hand, or in a safe at your home. While you may keep some money in physical cash, those funds won’t be earning any interest.
Most people think of “cash” as physical cash as well as money market mutual funds that invest in very short term debt while earning at least some interest.
Net worth is the totality of your assets. Therefore, net worth cash is usually kept in three places or accounts.
- An account from which all the normal bills are paid whether from checks, debit cards, or banking apps
- An Emergency Account for unexpected expenses or situations
- Investment portfolio cash or money market funds
Again, this post will be more focused on the first two types of accounts since portfolio cash is covered in my other post. We’ll also touch on investment cash, however, since portfolio cash is a factor for how much net worth should be in cash as you’ll see below. In other words, the two cash allocations, cash management and portfolio cash, are intertwined.
What Your Net Worth Cash Needs to Cover
You’ll want a percent of your net worth in cash so you’ll have enough funds to easily cover any of the expected or unexpected items 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, let’s keep them as part of the equation for estimating how much of your net worth to keep in cash.
Lifestyle Expenses Vs Emergency Funds
I like to call the first two expenses types above, Monthly and Extraordinary, lifestyle expenses since they are a function of where and how you live.
It’s important to remember that you get to control these expenses since they are a function of your lifestyle even though it may not always feel like it.
The last three expense categories qualify as financial emergencies. Unfortunately, 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.
- Investors are usually not prepared for bear markets but they’re inevitable for stock investors. .
- Recessions are simply a part of recurring economic cycles.
- The divorce rate is about 50% which causes a sudden need for two homes and two retirement plans.
- While natural disasters are less common, they happen.
Realistically consider the likelihood of each of the unusual events above. For example, just in my family, we have personally experienced a disastrous loss with a fire at my home, a costly loss from an ice storm, and hurricane flooding loss.
My mother in law’s home flooded and she vacated it in a raft.
Based on where you live, you can know if you should account for the unlikely event of a flood, hurricane, tornedo, or earthquake.
When it comes to job loss, certain industries are more prone to layoffs due to natural economic cycles.
Hope for the best while knowing the worst does sometimes happen, and be prepared for it with a well-stocked emergency fund.
Importance of Allocating Enough Net Worth to Cash
There are several main reasons why estimating the right amount of your net worth to keep in cash is so important.
Financial Peace of Mind
First, paying your bills with ease allows you to avoid financing costs and feel at peace about your money. No one wants financial stress. It leads to emotional investing decisions and mishandling of finances.
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 such challenges with your cash cushion will give you financial peace whether or not unfortunate financial events ever happen.
Avoidance of Undesirable Debt
Not having enough of your net worth in cash can lead to the need to borrow should you become financially strapped. This can result in high debt costs, poor credit, and even financial disaster.
Core Financial Planning and Investing Goals
Cash management around your monthly living expenses is at the core of your retirement income planning. It tells you how much money you live, which lays the foundation for retirement planning and investing.
Having enough cash allows you to do things in life that make you happy. Let’s face it, in addition to being able to pay the mandatory bills, life enjoyment is the ultimate goal of having money.
Keeping the right amount of net worth in cash 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 a long term investment that will trigger a capital gain tax at an already challenging time.
Now that you’re seen why it’s crucial to have enough of your net worth allocated to cash, let’s get into the math.
The Equation for How Much of Your Net Worth Should Be in Cash
Let’s explore the equation at the beginning of this article in more detail so you can calculate how much of your net worth to keep in cash with more certainty.
Monthly Living Expenses X Number of Months = How Much of Net Worth Should Be in Cash
Now let’s get into some good ole personal finance. Boring? Perhaps.
But I can almost promise you there will be at least one or two things you haven’t thought of in deciding how much net worth should be in cash so keep reading if you want to feel good about your money and pay all your bills with ease.
Part 1 – Monthly Living Expenses
The first step is to get a very solid number for your monthly expenses.
Below are some tips to fine-tune your monthly expense estimation. Remember, having this number wrong can destroy the best laid plan to not run out of money with which to pay the bills, the ultimate financial crisis.
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.
Nowadays, money flows out from many places, including automatic bank transfers, bank checks, investment account checks, wire transfers, various online apps, and multiple credit cards. And sometimes we’re almost forced to use a new resource for leaking out cash. For example, 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.
Now my son wants me to set up another app for transferring money easier.
The number of places money can flow out is endless, as you’ve probably noticed.
Assuming all of these money outflow venues continue to be safe, the number of places money can leave your possession will only 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 so it’s important.
I like to think of our monthly incoming cash as filling a bucket. Ideally, as much money as possible leaves that bucket to go into investing buckets for building wealth after our desired lifestyle has been covered.
Every place money flows out is a leak in that bucket, however, leaving less for building wealth through investing. Consider all the holes in your bucket.
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 like to download, copy and paste expenses into one spreadsheet to track our spending. Then I simply sort and 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 so far, right? It can, however, lead to always feeling behind financially 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
- Major home repairs
Extraordinary expenses are usually expected, but not monthly, making them different from emergency expenses.
For this reason, it’s easy to forget about extraordinary expenses until they happen. I like to keep a tab on my spreadsheet with all the few extraordinary expenses for the year since these can ruin an otherwise perfect wealth plan.
Having these expenses on a spreadsheet helps you be in control of your money, which leads to more good money habits, which leads to more wealth.
So, calculate your extraordinary expenses. Watch 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, cutting your expenses, and getting 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 any cookie cutter formula ever will.
Part 2 – Decide How Many Months of Expenses to Keep in Cash
Knowing your expenses was about simply 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 of living expenses, but you’re the one who will suffer if you’re wrong about the number of months to keep in cash so do your own calculations.
Sometimes the problem with financial advice is that it 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 and only you can decide what’s best for you as leader of your wealth.
Below are the factors to use for evaluating what percentage of net worth should be in cash.
10 Factors Affecting How Many Months 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.
Again, having too much of your net worth in cash can hurt your ability to build wealth and maximize investment opportunities.
On the other hand, having too small a percentage of net worth in cash can lead to not being able to pay your bills in an emergency.
So this step is super important to your overall net worth and financial security. But should you have six months or two years of living expenses in cash? Only you can decide but keep reading for more insights to help you decide what’s best for you.
1. How Much Is Your Net Worth?
Let’s face it. Someone with a net worth of $2,000,000 will probably need a smaller percentage of their net worth in cash than someone with a net worth of $100,000.
This is because high net worth individuals have a bigger asset base to rely on when financial challenges surface. But the two million net worth person may not have more in liquid assets. Keep reading because this is very important.
2. 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 which assets cannot. Assets that can be sold easily and quickly are liquid assets.
Investment Real Estate as a Percentage of Net Worth
Imagine someone with $3,000,000 net worth. Sounds good, right? But what if almost all their net worth is invested in real estate?
How will this affect the amount of net worth they should keep in cash?
For one, real estate takes more time to sell, especially when a financial crisis or economic downturn happens. The three million dollar net worth investor may not be able to access any cash by selling investments if all their money is in real estate.
The economic factors that affect how easy or difficult it is to sell real estate are often also the cause of personal financial problems among real estate heavy investors. Dave Ramsey claims this issue is what led to his own financial crisis.
When the economy is struggling, the markets in which your assets are invested, such as real estate in this case, often fall hard.
Plus, real estate buyers tend to delay purchases when the economy tanks, for several reasons. This often leaves real estate investors with their net worth tied up in assets that are not only hard to sell but that cannot be sold, period.
To add insult to injury, the investor’s overall net worth falls, too, due to the declining real estate or other investments. Such high net worth investors can become real estate rich but very cash poor, especially with real estate investors that are leveraged with highly mortgaged properties.
Home Values and Net Worth
The same scenario that applies to investment real estate can also be applied to homeownership. Home equity affects how much of your net worth should be in cash, although many people don’t realize this during good financial times.
Imagine someone whose home has appreciated in value to over a million dollars. 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 then moving. Buying a replacement home almost always involves getting new financing, which can be hard to get should unemployment happen as a result of changing financial times.
Plus, taxes could possibly be due on a home’s sale, depending on the amount of profit.
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 conveniently with your need for cash.
All this to say having your home as a major portion of your net worth can lead to serious financial problems if you don’t have cash.
Therefore, think in terms of liquid assets when deciding how much net worth to keep in cash.
Depending on how much of your net worth is in your home, it can make good sense to see if downsizing is right for you as explained in my video below.
Investment Portfolio Cash Is Very Liquid
When compared to someone with a high percentage of net worth tied up in real estate, stock and most bond investors will generally need a lower percentage of cash to net worth since they own very liquid assets.
While a stock investor will experience nasty bear markets when they occasionally happen, most stocks can be sold in less than a minute, and you usually have access to your money within 3 days. Viola.
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.
Defensive assets such as 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 and highly liquid. Therefore, having a high percent of net worth in highly liquid assets decreases the percent of net worth that needs to be in cash.
While spending investment capital isn’t desirable, sometimes it needs to be done to pay the bills temporarily.
3. Cash Allocation in Portfolio Affects 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 since you’ll want to factor in portfolio cash when deciding how much of your net worth should be in cash.
Most traditional investment portfolios have assets allocated (divided) among stocks, bonds, and cash. But if, for example, you’re a proactive investor who has decided to increase cash in an effort to increase returns, you may already be holding an unusually large percentage of investment capital in cash.
Remember, 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. Think of your net worth and investment portfolio as one big financial picture, however, since you can probably tap into your investment cash as a last resort should you need it for living expenses or financial emergencies.
But also consider 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. (You can borrow from IRA’s but check with your CPA since the rules vary and change frequently.)
4. Overlooked Liabilities Increase the Percent of Net Worth Cash
One unforeseen liability can change everything. Make sure there are no overlooked liabilities that would increase the need to keep a higher amount of net worth in cash.
Tax liabilities, lawsuits, and cyber security risk are all realities of life.
Fortunately, measures can be taken to limit such unexpected liabilities, such as good financial order, safe computer use, and various insurance policies.
5. Health Issues Increase the Amount of Net Worth to Keep in Cash
While many health problems can’t be anticipated, some can.
Consider if you have potential health issues that could lead to you being unemployed or incurring expensive health care costs that aren’t covered by insurance.
If so, you’ll want to adjust the amount of net worth you keep in cash accordingly so you’re not forced to liquidate an investment at an inopportune time to cover medical expenses.
6. 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 more fixed expenses you have, the higher your cash as a percent of net worth will need to be.
7. Dependents Increase the Cash Net Worth Allocation
Young or adult children that are in a financial bind, aging parents, or other dependents increase the amount of net worth you’ll want in cash. This is a big topic 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.
8. More Income Earners Lowers the Needed Level of Cash
The risk from potential job loss is lowered by having more than one income earner in your home. Therefore, for every additional income earner, you should 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 and relevant skills that can be used to increase income immediately if needed.
Examples of easy to obtain skills include social media marketing, content marketing, video creation or editing, graphic design, technology skills, and consulting, to name only a few.
There are many low capital businesses to start later in life now that the internet provides endless opportunities.
9. Income Streams Can Lower the Percentage of Net Worth in Cash
The more sustainable income streams you have, the less the percentage of net worth you’ll need in cash since you’re more likely to be able to cover living expenses from diversified income sources.
Below are some examples of such income streams.
In your cash to net worth income evaluation, consider passive income from investments, such as dividends and interest.
Note that unless you’re in retirement, you’re probably reinvesting investment income as an important part of your wealth building routine.
In this case, however, 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 unless you’re reached your financial independence number.
Alternative Income Streams
Or you may have alternative investment strategies in income generating assets, such as real estate 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.
Starting an online business after 50 has gained popularity with all the tools to make this easier than ever, although in an ever changing and competitive landscape.
While many people think it’s too late to start an online business, there are so many different types of online businesses there is literally something for anyone wishing to pursue this income source. It is ideal for anyone with a fear of retirement boredom.
I include the importance of alternative income streams from real estate, consulting, or online business as I have learned firsthand that they work. We have completely replaced job income with alternative income streams over the past 15 years after stumbling upon early retirement.
Debt Affects How Much of Net Worth to Have in Cash
The amount of debt you have will affect how much of your net worth should be in cash for several reasons.
I’ll own here that I do think there is good debt and bad debt.
In general, however, 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 potentially positive outcome.
High Investment Risk
Portfolios with a high amount of investment risk call for a higher amount of net worth cash since the investor’s overall financial situation is riskier.
How Much of My Net Worth Should I Invest?
Many individuals decide how much net worth to keep in cash after deciding how much of their net worth they should invest in various assets. This approach puts the horse before the cart and here’s why.
The reason to have enough net worth in cash is to be able to handle any financial emergency that might arise. Doing this allows us to invest with confidence.
Therefore, it makes sense to first address the many factors in this post, such as income sources, asset liquidity, and number of dependents.
After this has been done, an investor can decide how much investment capital to allocate to stocks, bonds, cash, and other asset classes.
Over the past few years I have personally invested using a strategy that rotates into higher levels of cash when warranted which I found on Allocate Smartly.
The Bottom Line for How Much Net Worth Should Be in Cash
As you can see, there are many factors affecting how much net worth to keep in a cash equivalent account.
Hopefully, I’ve touched on a few you may have not considered.
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.
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