How much cash do I need and where should I keep it?

I mostly talk about long term investing and putting your money in the stock market. But we all should have a certain amount of cash on hand. While this is probably the easiest part or your financial plan to implement it is often the most ignored.

This is especially true with interest rates so low. Most people assume that with interest rates so low it is not worth their time and effort to search for the best rate, but that is not true.  If you have $10,000 in cash going from 0% interest to 1% interest means an extra $100.00 a year. Who wouldn’t like an extra $100 every year? So how long does it take and is it worth your time to earn the extra $100.00 every year?  The reality is it probably will take you less time than you spend clipping coupons or driving to the cheaper gas station to save 50 cents here or $1.00 there.

There are some online banks that will pay you 1% interest or more for a savings account.  You can set up an account in 10 minutes and then link that account to your favorite bank or credit union checking account. With the link you can transfer the funds back and forth as needed in under a minute. (There may be a day or two lag time for the funds to be available, so you just need to time when your transfer the money if you need it.)

The reality is most people need to have much more than $10,000 in cash so the more you have the more meaningful the rate of return on that cash will be. So if you have $100,000 or more in cash that one percent increase in the rate of return will mean an extra $1,000 a year to you for every hundred thousand you have!  Even if you increase your rate or return by only 0.1% you are still getting an extra $100 a year for every $100,000. All this extra money for very little effort on your part.

When I review people’s financial plans I am usually able to help them increase the rate of return on their cash holding by at least 0.5%. The math is easy, that equals $500 extra every year for every $100,000 they have in cash. If you have not paid attention to the rate of return on your cash, my guess is you can increase it by at least a half a percent. This is not hard to do, just google savings account rates on the internet and shop around for the best deal. As long as the bank is FDIC insured and you don’t have more than $250,000 in any one account your money will be safe. You can increase the rate return a little more by setting up CD ladder depending on when you think you will need the cash and the purpose of the cash.

Now the bigger question is how much cash do you really need? Aggressive investors such as me don’t want to have any more money in cash then they have to because rates are so low at the moment.  I often have to remind people (including myself) that the stock market is for long term investing so you should not be putting money in the stock market that you may need to use in the next five to ten years.

How much cash you need depends on your own situation and tolerance for risk. Are you saving for a down payment on a house or paying for yours or someone else college tuition in the next couple of years? If so that money should be saved in cash. At a minimum you also want to have enough cash on hand to cover any emergency purchases such as a new furnace, and to also cover at least six months living expenses should you lose your job. If you are older or in a higher paying job where it may take you longer to find a new job, you may need to have a year’s worth of cash on hand. If you’re married and your spouse is also employed you may need a little less depending on the likelihood of both of you being laid off at the same time. If you are in or nearing retirement, and need cash to help supplement your retirement income, you will need to have at least a five year supply of cash on hand to meet those needs.  Unless you are already 60 years old, any cash you are likely to need in the next five years should not be held in IRAs or 401Ks as you will have to pay taxes and a tax penalty to take the money out.