Month: April 2022

How Much Cash Should You Keep On Hand?

It’s impossible to give general numbers as to how much cash you should keep on hand in retirement. It all comes down to an examination of your expenses. Someone living in a home they own in a rural area in Tennessee will have significantly different costs from someone living in the Bay Area in a rented unit.

To calculate how much cash you should keep on hand, you first need to have a solid idea of your monthly expenses. Maybe you’re spending $3,000 per month on typical living expenses. Perhaps that number is closer to $10,000 for other people. Keep in mind that this number is likely to rise over time. The cost of living keeps going up in 2022, and everything from energy to food to medical care is most likely going to grow more costly.

The second thing you need to know is what other sources of income you may have. Even though you’re retired, you may have additional income streams. 

Income can come in a few forms:

• If you’ve worked a career that has accrued a pension, that pension will pay out once you retire, with a fixed amount each year. Pensions are less common than they used to be, but they aren’t entirely gone quite yet.
• Social Security. As a government-managed and public program, social security is a basic income for anyone of retirement age. Some people don’t qualify for social security income – exceptions include a variety of relatively narrow categories of people – but it still provides a consistent, if low, income for most retirees. There’s some doubt whether social security will still be available in a few more decades, but if you’re retiring now, you should have it.
• Supplementary income.  Many retirees pick up hobbies they can monetize (for example, selling handicrafts online) or pick up a part-time job to have both preoccupation and income. You should count this income as well.

Now that you know how much it costs to live and how much you’re pulling in from various non-investment sources of income, what category do you fall in?
 

• Under-covered. This scenario is by far the most common position. Your expenses are higher than your income. These expenses are paid with disbursements from your investments.
• Your income and expenses balance out, so you can leave your investments alone.
• Over-covered. You make more than enough from your non-investment sources; you don’t need to worry about running out of money right away.

Generally, it would help to calculate your necessary cash on hand based on the discrepancy between income and expenses. 

For example, suppose that your costs of living sum up to $7,500 per month. Your income covers a little under half of your expenses, leaving $4,000 per month to come from somewhere else, typically your investments. 

Let’s say you have $2,000 per month in a pension, $1,000 per month in social security, and $500 per month in part-time income.

To calculate your emergency fund, decide how many months you want to be covered. Pre-retirement, the general recommendation is 6-12 months. In retirement, opinions differ. Some financial advisors say 12-18 months, while others say 24+ months. 

Consider this: the larger your cash on hand, the more insulated you will be from economic hardship by adjusting your investments. The markets can take between 6 and 18 months (or sometimes longer) to recover from a downturn, so you want at least that much set aside to pay expenses to avoid tapping into your investments which you’d be selling for a low value.

Moreover, different investment portfolios may take more or less time to recover. An investment made of half stocks and half bonds, for example, can take up to 40 months to fully recover from a downturn. 

In our example, with $4,000 per month in expenses not covered by a stable income, you would want:

• Twelve months of coverage, or $48,000 in cash on hand.
• Eighteen months of coverage, or $72,000 in cash on hand.
• Twenty-four months of coverage, or $96,000 in cash on hand.

So, somewhere between $50,000 and $100,000 is the right number in this hypothetical scenario. Your numbers will vary quite a bit depending on your unique living situation.

Just because you retired doesn’t mean you want to cash out all of your investments. Long-term investments can continue to grow as long as you have the luxury to let them. You never know how long you’re going to live after retirement or what unexpected expenses mar arise. 

You want your investments to stay as large and as stable as possible for as long as possible and only tap into them in the case of an unavoidable emergency.

Remember, as well, that you may have other sources of funds in an emergency. You may be able to leverage a home equity line of credit, the funds in a Health Savings Account, or other credit lines if you need them before tapping into your retirement accounts.