Carrying a high cash reserve can be a controversial topic. On one hand, you forgo the higher compounding interest you would earn if the money was invested. On the other hand, you need cash for living expenses, emergencies and to make planned purchases. What drives the amount of cash you hold? Usually, it’s your financial goals, investment horizon (amount of time you have to save or invest) and your risk tolerance. How much of a cash reserve should you have? The answer will vary based on your needs, but I think having a high cash reserve can be beneficial.
What can happen if you have too little cash?
Although we are individuals, a quick look at business statistics might help. Multiple sources cite 80% of businesses fail annually. I randomly picked an article from 2016 (from smallbiztrends.com) which cites ten reasons small businesses fail. Several of the reasons relate to money and planning: insufficient capital, improper planning, poor management and leadership, expanding too quickly, and unprofitable business model (you can read the full article here).
According to bankrate.com, more than half of American only have three months of emergency savings and 28% have no savings at all. Like businesses, individuals and families can fail financially. Without a cash reserve, people risk going into debt, experiencing a poor quality of life, not being able to afford basic needs, defaulting on loans, and some file for bankruptcy. Having a larger cash reserve can help you avoid financial distress and better handle the unforeseen.
Cash affords you choices, opportunity and freedom
Having a significant amount of cash allows you to pay for emergencies (car repair, medical expenses, unplanned trips) without having to charge it on a credit card, take out a loan, or dip into funds allocated for other financial goals. Cash gives you a cushion and allows you to make choices. You don’t have to choose between providing care for one family member while sacrificing the well-being or happiness of another. You also don’t have to dip into your retirement savings to pay for expenses, which could potentially derail your future.
Cash allows you to be selective and provides you time to make decisions. For example, if you have a year’s worth of salary saved and you lose your job you don’t need to panic – you can take time to find another position commensurate with your experience vs. taking the first job that comes along out of desperation. Cash also affords you investment opportunities: starting or increasing your investments, purchasing an investment property, investing in a business, etc. If you have enough cash you can travel, take mini-retirements, choose how you spend your time, and it provides you freedom to do anything you choose. To me, the latter is priceless!
What we’ve purchased with a large cash reserve
Personally, we’ve been able to make several large purchases in cash. These purchases include cars, down payments on properties, additional schooling without loans, home renovations without taking out a home equity line of credit (HELOC), increased investment contributions during market down-turns, and we’ve traveled to spend time with family. Having a higher cash reserve will continue to help us finance our short and long-term goals.
If you “fail to plan, you are planning to fail” (Benjamin Franklin)
By no means do I support saving all of your cash. I strongly encourage you to invest and live life; just don’t neglect the importance of having cash. The point is, have a plan to invest and build your cash reserve. Create your own path and financial destiny! The greater your cash reserve, the larger a financial storm you can survive, and the more choice and opportunity you’ll have.
We maximize our retirement investment accounts, invest in non-retirement accounts, have emergency savings, travel/fun funds and divert some money into a high-interest savings account. Our savings provides a lump sum of money in case we need or want to use it (adoption, another investment property, etc.). Sometimes we reduce or halt the money going into our savings account (if we have a high expense month) and sometimes we infuse additional savings (i.e. tax return, bonus, birthday money, etc.).
Don’t know where to start saving? See my post about how I’m using Digit to save additional money.
Incorporate cash savings into your financial plan
Lack of money and planning account for half the reasons small businesses fail. More than half of Americans only have a few months’ worth of emergency savings which opens them up to financial disaster. Take time to figure how much cash you need (and want) and incorporate cash savings into your financial plan. A combination of investments and cash can help you finance your goals!
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