When it comes to investing your money, remember that cash is an asset class! Every single asset allocation model has a percent of your money that stays in cash. (Remember an asset allocation is just investing your money into different categories, like stocks, bonds and cash, based on a certain chosen percent.)
Investing Your Money: How Much Is Enough?
You may be wondering how much money you should keep in cash. The short answer is that you’ll want the amount of cash that allows you to live without financial stress while reaching your goals. The long answer completely depends on several factors around your money, how long you plan to invest, and where the market is in the current cycle. In this article, I’ll cover some of the most important factors to consider when determining how much money you should keep in cash.
Resist Fear of Missing Out
First, I want to point out that it can feel like cash isn’t a true asset class. Especially if you haven’t been investing your money in traditional investments while the stock market has been rising. The longer the market is rising, the harder it is to have your money in cash. Fear of missing out can eat away at you during rising stock markets.
Past Does Not Guarantee Future
The most common mistake investors make is making a hasty or uninformed decision to jump into the markets because they don’t want to miss out on the returns. These are returns that the stock market has had over the previous few years. This pertains to every time frame, the past, present and future. As every investment product disclaimer states: past performance is not a guarantee for the future performance. In fact, the longer the market has been increasing, the more likely it is to correct. This is because the stock market corrections occur every few years, as you can see by clicking here.
Cash Is Not Literal
Again, the point to remember is that cash is an asset class. This simply means that cash is a type of investment. The bad thing is that cash doesn’t have a good return on investment, period. The great thing is that it is always there when you need it since it doesn’t drop in value. For our purposes, cash doesn’t mean the money in your purse or under your mattress. Cash is very short-term investments that don’t swing in value.
Having clarified this, here are a few tips to help you figure out how much money you want to keep in cash. Not to state the obvious with some of these tips. However, sometimes seeing a list helps you work through the situation and take action, at least it sure does for me!
Amount of Liquid Assets
While this may seem obvious, studies show that women who have $2,000,000 in their investment accounts worry as much as women with $5,000 in investments. The reality is that someone with $2,000,000 in liquid assets probably needs less money in cash than someone with $5,000. This is simply because there is more money to pool from when things get tough. The reason many more affluent investors worry is that their lifestyle expenses, and possibly debt, have increased with income. This makes it cost more to sustain their lifestyle. The solution is to live a conscious lifestyle with a deliberate spending plan. This way, you can be happy and worry free when it comes to your money.
Amount You Spend
This circles back to the point above, reinforcing to live and spend consciously for true financial freedom. One sneaky way to do this is to pretend like you make 10% less than you really do. Covering your monthly expenses guides how much you’ll need in cash to cushion bad financial times. Obviously, the less you spend, the easier this one is! Tip: Just take a look at how much you spent last month by downloading your credit card expenses. Take a quick stroll through your bank account expenses to immediately feel more empowered around this.
Amount of Fixed Expenses: Mortgage, Utilities, and Insurance
Some of your expenses can be cut quickly and easily. Think shopping sprees for things you don’t really need, dining at moderately priced restaurants instead of expensive ones, and manicure and pedicure instead of spa days. Fixed expenses like the mortgage and insurance don’t have much wriggle room without making bigger changes.
Number of Dependents
Young or adult kids that are in a bind, parents, or other dependents catapult your cash requirements. It is what it is.
Investment Account Protection
Do you have strategies in place that mitigate risk from systemic drops in your investment accounts? This may be a proactive asset allocation based on the current markets. Or, investment hedging strategies such as buying puts, or selling short. While this may sound risky, many funds and most corporations use these sophisticated wealth techniques.
A Common Strategy
Another common risk management strategy is investing your money in non-correlated assets. This just means you’re invested in assets that move up when your other investments are moving down. Unfortunately, during major stock market corrections, most investment classes decline in unison. But, savvy investors and wealth managers find diamonds in the rough.
Income hedging is a reflection of how many employed adults in your home are generating income, and how many layers of income. In this regard, the more the merrier. For this reason, I always suggest keeping marketable skills of some type. Do this even if you are not currently working. Meaning keep skills that will generate income outside of your current job if needed.
How many sustainable income streams do you have? This may include passive income from investments, such as dividends and interest. Or it may include more active income streams, such as real estate rentals. Small business, such as consulting or online income is another income strategy that many are using now. This is due to the ability to potentially reach millions over the Internet at a low cost.
Consider Personal Variables
Financial advisors usually suggest that you keep 6 to 18 months of living expenses in cash or cash equivalents. Again, this is money that you have NO RISK of losing. While it’s not an excuse to avoid putting your money to work, it’s your sleep well at night money. Only you can really decide how much this amount should be based on a number of variables that apply to your financial situation.
Your Financial Peace
You may notice that expenses, investing your money and income streams are intertwined elements from this list for wealth creation and financial peace. At its highest level, having enough cash is really about financial peace so you can live a low stress life with the things that make you happy.