No one wants to run out of cash. By cash, I mean that super safe stash you keep in a money market account that won’t fluctuate in value the way stocks do.
But just how much should you keep in a money market account? It depends on some personal things like your investments, portfolio allocation, dependents, and income sources. But believe it or not, it also depends on the economy!
Plus, there are a few more factors that I think are super important as you’ll see below.
As always here at Retire Certain, I won’t pretend there is a one size fits all answer with anything as important as your money! And having enough money in a money market account means not running out of money when faced with the random but inevitable financial challenges that life throws us.
Between my 40 years of personally investing, juggling family finances and my AFC® training, I’ve learned it’s important to look beyond the most common factors to discern how much money to keep in a money market account.
There are the personal finance factors, such as age and expenses, but there are also the investment risk factors. It’s important to consider both to get through financial challenges while also optimizing investment returns.
This can be tricky, but the more you know, the better position you’re in to be able to have the money to live how you want both now and later.
(It happened again: My intention was to keep this post under 1000 words. I couldn’t do it. There’s too much that needs to be mentioned with an important topic like this, so make sure you read it all.)
Why Money Markets Are So Important
There are two major elements for how much to keep in a money market and why this is such a big deal.
First, there is the ability to cover emergency expenses, or not run out of money.
Second, there is building wealth from investments which is heavily affected by money market levels as you’ll see below.
The two elements are intertwined so I cover both objectives but you can read what applies to where you are right now.
Rule of Thumb for Money Market Expense Coverage
The general rule of thumb is to keep 6 months to 2 years’ worth of living expenses in a money market or similar account.
This is very broad. Again, regular readers know I dislike rules of thumb. They give us all an excuse not to make our own decisions.
But since you’re the one who will run smack out of cash if you don’t have enough in a money market during times of unanticipated financial turmoil, you’re the best person to make such a decision. So, keep reading.
And note that none of these are standalone factors. In fact, one or two factors here can make all the other factors almost irrelevant.
Money Market Equals Cash
In this post, I’ll assume that a money market account is where you keep your liquid cash savings. This is what most investors do since it allows them to earn a little interest on their “safe money”.
The important distinction to make about money markets vs other funds is that they do not fluctuate in value.
In general, money markets are the safest choice to maintain a consistent value other than cash, but money markets pay interest so we prefer them over non-interest earning cash.
Why Money Market Accounts Are Safe
Money market accounts invest in very short term and high–quality debt. For this reason, they are not subject to swings in value from factors like the economy, interest rates or financial turmoil, so I like to call it “safe money”.
You can easily see what’s in your money market account by ‘Googling” it like this: Type in the name (or symbol) of your money market account in the Google search bar, choose a result, and then look for a “Holdings” tab or scroll around to see what your money market is invested in.
Below is an image from Vanguard’s Prime Money Market Fund, VMMXX, which I made after following the simple process above to provide a good example. (I have no affiliation and do not have money in this specific fund as of this writing.)
Important Money Market Factors
On the image, I noted the major holdings, average maturity and number of holdings with red arrows so you can easily see these important factors that contribute to maintaining steady money market values.
For example, there are 400 holdings so it’s diversified.
And you can see that average maturity is only 47 days, so these holdings are very short term.
Note that this money market fund does have a high percent (54.7%) of assets in Yankee/Foreign securities, which, I noticed has earned a little concern from some analysts and investors.
But I digress. The point is that you’ll want to know where your “safe money” is invested by seeing what, exactly, your money market fund has bought with your money.
I explain more about this in my post What Are the Risks of Bonds?
Now that you know just how your safe money’s invested, let’s move to some factors that affect how much to keep in a money market account.
Household has one income earner
If there’s only one person contributing to household income, you’ll definitely want to consider this in deciding how much money to keep in a money market.
If that one person loses his job, you’ll have to dip into your money market account to pay expenses for however many months it takes to become employed again (unless you have other income sources – see below.
On the other hand, families with more than one person earning money will have that second income source to get through the period of lost income from the second income earner.
Number of Income Sources
If you have no income sources except employment, this warrants keeping a higher percentage of cash in your money market account.
Examples of other income sources are things like real estate rental income, or other alternative investments.
Small business income from blogs or websites also count as other income. They are a favorite income source of mine these days given their exceptionally low capital to start. (Read more about this in my post Starting an Online Business After 50.)
Other income streams will get you through the tough times should you lose your employment income due to a recession or other reasons. And if you don’t have any other income sources, you’ll need to sell assets, such as your home or stocks, possibly at less than opportune times, if times get tough.
Read my related post How Many Income Streams Should You Have?
If other bread winners in your household are employed in economic sensitive industries, note this as an influencing factor for having more in your money market account.
Examples of economic sensitive industries include finance or real estate. Other industries, such as oil, can run into long unemployment trends.
Stories of Economic Sensitive Sectors
I remember going to a wedding in Houston in January of 2016. The number of people there who were without work was astounding. We left the wedding depressed!
And, for many, their spouses were in the same industry or industries affected by low oil prices, such as real estate, along with almost all commerce in the Houston area.
Similarly, the economy of my hometown, Tupelo, Mississippi, suffered greatly after the main industry, manufacturing furniture, was moved to China.
Bad times tend to trickle down like hot water in a glass of ice affecting everything along the way.
And these are factors beyond out control.
If both you and/or another main breadwinner could be affected by a downturn in your local economy, this can be a little red flag for a higher percent of money market cash.
This one’s easy: The more dependents you have, the more you’ll want in your money market account.
Think of potential dependents, too, such as aging parents or adult children that you may want to help financially should the need arise.
Time Until Retirement
If you plan to retire within 0 to 15 (or even 20) years, a higher level of money market cash may be warranted. I get that 0 to 20 years is a very long time frame but here is why I use it based on what I’ve seen over the decades.
Let’s say you retired in 2000 just before the 2 bear markets of the 2000’s with a significant amount of retirement savings in stocks.
Based on published returns, you would have probably had a slightly negative return from stocks 10 years later! Then, you’d need to build up from the bottom. By this time, you’d be in your mid-70’s if you retired at age 65.
This is why I think considering retirement within up to 20 years is reasonable in planning how much to keep in a money market account.
Retirement and Bear Markets
By the end of the second bear market in the 2000’s and the related financial crisis and recession, a lot of people had run out of reserve savings because they didn’t have enough in money market accounts.
And this led people to have to sell stocks and real estate near the bottom of the cycle. This is exactly what investors want to avoid, and one of the reasons to keep a nice cushion of cash in money markets or investments that go up when stocks go down especially when markets are expensive if you’re near retirement. (see below).
Retirement and Bull Markets
On the other hand, if you retired in 2009 and bought heavily into stocks that year, you would have had over a decade of rising stock prices to powerfully fuel retirement savings in stocks.
But this time frame is really related to the other factors you’ll see here. Again, none of these are standalone factors.
For example, if you have high net worth, multiple income streams, and little debt, then the fact that you’re retiring in 1 year is probably not as relevant in determining how much to keep in a money market account.
On the other hand, if you’re already living outside or close to your income and have to service mortgage or other debt, you’re in a completely different situation.
This supports my philosophy that there are no hard and fast rules that apply to everyone.
So the time until retirement is an important factor affecting how much to keep in a money market, but it’s more important in relation to the economic factors lower in this post so stay with me.
Read my related post How to Know If the Stock Market Will Go Up or Down.
This is another easy factor. If you’re living near or beyond your means, you’ll want a higher amount in a money market account. By this, I mean that you don’t have substantial wealth based on your lifestyle expenses.
For example, you commonly spend more than you make, have little savings, and have a lot of expenses.
If your debt is medium to high relative to your income, you’ll definitely want to consider this in deciding how much to keep in a money market account.
This is because those debt service payments will need to be made no matter what. This is true whether your debt is for a home or for credit card debt.
Now we have addressed all the easy to understand and more personal finance related factors for deciding how much to keep in a money market.
Let’s move into the more advanced factors that are sometimes overlooked simply because they are more complex. I say let’s bring them on!
Money Market Vs Stocks
The following criteria is assuming that, like most investors, you are deciding how much to keep in a money market account vs stocks, since this is the most common investment. It’s also important to note that the factors below, do, however, also affect real estate prices.
This means your home value and net worth will be affected by them, as well.
Bear Market Risk
A lot of investors feel like they have too much risk in the stock market but stay in it anyway. Often, people aren’t sure where else to invest besides stocks. And sometimes, there aren’t many other good investment options.
Other times, investors succumb to pressure from well-meaning financial advisors or family.
But a lot of investors just don’t understand how a bear stock market will affect their net worth. A bear market may cause more damage than you suspect but it may also be less since stocks are only one part of your net worth.
This is why I created a little process to estimate stock market risk at any given time based on historical facts and data.
This is a very important factor in deciding how much to keep in a money market because it gives you excellent insight into how much risk you have.
You can do that process in my post How Will a Stock Market Crash Affect Me?
If you’re not okay with the amount of stock market risk you have, this is another clue you may want to keep more in your money market account based on your own circumstances.
So often, we feel like victims of the stock market but you get to choose the risk you want at any time!
Just keep in mind that it’s a trade off. The most you’ll make from a money market account is the interest you’re earning while stocks go up and down, and many pay dividends, too.
My article, Predictors of Bear Markets, has a great bear market checklist that can help you have a better handle on stock market risk, too.
In most cases, someone with a net worth of $250,000 will want more money market cash than someone with a net worth of $2,000,000.
This is because the person with a higher net worth has more assets to pull from should the need arise.
This is not a given, however, since expenses tend to rise with net worth, and due to the next factor.
The amount of liquid assets you own is a big factor for how much to keep in a money market. If most of your net worth is tied up in real estate or small business, for example, it takes time to get access to that money.
On the other hand, you can gain immediate access to funds from selling most stock and bond investments when there’s an emergency.
Stocks Highly Valued
The amount stock investors have to pay for earnings, as shown in a PE ratio, is a valuable and simple to understand tool.
When the PE and/or CAPE PE ratio of the stock market is near or above historical highs it can be wise to move a higher percent of your money from stocks to your money market account.
This will reduce overall investment risk as well as allow you to have cash to buy stocks when they are cheaper near the end of bear markets. The downside of such a move would be if stocks keep going up, you’ll miss that upside.
Again, investing is a trade off between risk and reward. It’s important to make a decision based on your own situation, instead of following a blanket asset allocation and not understand the consequences.
Note that high stock valuations are a common reason the best wealth managers and high net worth investors raise the amount they keep in money markets vs stocks in anticipation of bear markets and lower stock prices.
Note that the common practice of re-balancing portfolio allocation among stocks, bonds and money markets naturally increases cash and bonds as stock prices rise.
Cash Is an Asset Class
Interestingly, I’ve noticed that many asset allocation models don’t include money market accounts. I worked with one financial advisor who liked to remind clients that cash (money market accounts) is an asset class.
Indeed, it is. Cash in money market accounts doesn’t hold much upside potential, however, until you can buy quality assets at discounts of 30% to 50% of what they were just a year or two prior.
Then, cash in money market accounts can be used to build wealth off the bottom.
My related post How to Manage Risk in the Stock Market has more on this.
To further prove the fact that cash is an asset class, see the MFS image below.
Notice that reliable but not stellar cash (yellow box) was the top investment performer in 2018. It was near the top in 2008 and in 2001.
Image Source: https://www.mfs.com/content/dam/mfs-enterprise/mfscom/sales-tools/sales-ideas/mfsp_20yrsa_fly.pdf
While it may sound completely unrelated to your personal net worth and financial goals, the economy is one of the best guides for increasing or decreasing money market percentages.
Growing economies ensure jobs and fuel rising stock markets signaling the need for less cash in money market accounts.
But when the economy has been growing for years, it will eventually reach the end of the expansion. Then company profits decrease in the slowing economy.
As a result, the stock market declines, usually into a bear market. Remember, a bear market is a decline of 20% or more.
Not only is the stock market affected, but jobs are lost, too. And this circles right back to earlier factors about employment and income sources.
Unfortunately, due to “recency bias”, we forget about slowing economies until it happens again.
Knowledge of whether the economy is growing or slowing can be a valuable factor for how much to keep in a money market account.
Don’t fear it, just understand it and use it to your advantage.
Citibank’s Bear Market Checklist
The data researchers and PhD’s at Citibank are way smarter than me. They have put together a remarkable checklist of bear market predictors that include the other factors listed here, such as the economy slowing and high stock valuations.
So, you can really just take a look at this checklist on my post Predictors of Bear Markets.
This bear market checklist can be a little overwhelming if you’re new to this. Don’t feel like you need to understand everything on the checklist. (Confession: I don’t!)
Just notice if there are a lot of warnings marked in red on the checklist. If there are a lot of red warnings, it can be a reliable signal to increase your money market account.
Assets That Move Opposite Stocks
If all your assets (investments, real estate, home) move in the same direction, you may want to consider a higher percent of net worth in your money market account.
Lately, more older investors have higher percentages of their investments in stocks than was previously considered “normal” based on their desired risk. This is because bonds have such low yields and limited upside potential.
One of my financial coaching clients in her early 60’s was told by her financial advisor she needs to “catch up” by increasing the amount of investments she has in stocks. This is not uncommon.
Some investments, however, almost always move up when stocks move down. One example is U.S. Treasury bonds.
But if all of your net worth is tied up in the stock market, and in your home, as opposed to at least some assets that move counter to stocks, a higher percentage of net worth kept in a money market account may be warranted.
Medium to High Risk Investments
If much of your net worth is tied up in high risk investments, a higher percentage of money market cash probably make sense. While a list of high–risk investments is exhaustive, just to provide some examples, they might include:
- Any investment with high leverage
- Any investment you don’t understand
- Overvalued investments
Summary for Money Market Allocation
As you can see, this isn’t your usual list of factors for how much to keep in a money market. This is a very important consideration for investors since it greatly affects both investment performance as well as risk.