How much cash should I have on hand?

Whether you’re saving for a short-term goal, preparing for a major life event or a new career opportunity, or even trying to sleep better at night, cash can be a powerful tool to help you do it all.

Here is how you can determine how much cash you should have on hand, what to do if you have too little or too much, and how to proactively plan for cash as an asset that can both protect against risk and allow you to take advantage of new opportunities through life.

Why people have too much cash on hand

There are several reasons why people hold too much cash, and most have to do with uncertainty or lack of clarity around how cash fits into their broader financial picture. 

Here are some reasons why people may have too much liquid reserves sitting around:

• Emotions attached to money: All aspects of money, including cash, are emotional topics. The psychology of money (how we think and feel about it) can drive us to hold on to too much of it. Whether it’s a desire for a feeling of safety and security or to alleviate the stress and anxiety that comes from uncertainty, cash can satisfy both.
• No plan for how much they should have: The number one reason people have too much cash is that they don’t know how much they should have. Said another way, they don’t have a plan that informs what amount they need and how it supports their life today, tomorrow, and in the future.
• No plan for what to do with it: In some cases, people know they have too much cash, but they aren’t sure what to do with it or how to put it to work. There may be conflicting goals and priorities, a lack of clarity around necessary trade-offs, or uncertainty around how best to use or invest the money–all of which can lead to inaction, and inaction leads to too much cash.
• Uncertainty over investing: When people aren’t confident it’s the right time to invest their money, they are more likely to keep it on the sidelines. News about recessions, market downturns, rising inflation and interest rates can all add to uncertainty around investing, and people tend to be more cautious during periods of uncertainty in the markets.
• Uncertainty over a life event or transition: When people are approaching a major life event like starting a family, buying a home, or changing jobs or careers, they may want extra cash on hand. In these situations, cash can provide peace of mind and certainty. This isn’t necessarily a bad financial decision, but there needs to be a plan for when and how the cash will be put back to work.

With a better understanding of why people hold on to too much cash, let’s look at how much you should have as part of your ongoing financial plan.

How much emergency cash should I have on hand?

The number one reason people have cash on hand is for an emergency fund. An emergency fund is a savings account set aside to protect against unexpected expenses (car or house repairs) and events (loss of a job or a health issue).

Your emergency fund acts as a safety net against a financial loss. It can protect your other assets and keep you from having to use high-interest-rate debt to cover unexpected expenses. Finally, it can provide peace of mind knowing that you and the people you care about most are protected should the unexpected occur.

Savings set aside for an emergency fund should be put in low, if not no-risk assets like cash, checking or savings accounts, or even certificates of deposit (CDs). You want to know the money will be there and that it’s easily accessible (liquid) should you need it in a hurry.

For an emergency, having three to six months of expenses in cash is the rule of thumb. However, your actual target depends on whether you live in a single or dual-income household, the stability of your job, your desire for peace of mind, your family situation, or other personal variables.

How much liquid cash should I have available?

When it comes to cash, most people think about their emergency fund, but there’s more you need to plan for regarding how much to hold. The right amount will depend on what you’re saving for, such as:

• A current or short-term goal: Any goal within the next two to three years should be saved using cash or other easily accessible (liquid) and risk-free assets (like savings accounts or CDs). This money should not be placed at risk as you need it in the near future. How much you have on hand depends on the goal you are saving for (e.g., a new car or house, home maintenance, or renovation).
• A life event: When it comes to bigger life events—getting married, starting a family, buying a home, or even a career change—there is always excitement and a little bit of uncertainty about the financial changes that will come with them. Not only do you want enough cash on hand to cover the actual expense itself, but it can be a good idea to have a little extra cash saved to help cover some of the “extras” or upfront expenses.
• An opportunity: If you are planning for or even thinking about moving, changing jobs or careers, or maybe taking a break to travel or volunteer, having extra cash on hand can be very beneficial. It may just be your ticket to capitalizing on a new opportunity or exploring what truly matters to you. Greater flexibility often comes with a greater sense of freedom.

Cash can be a very valuable tool when used properly as part of an overall strategy, but too much cash can put a drag on your plan and the return you get on your money.

How to make your existing cash work harder for you

In a low-interest rate environment, there aren’t too many options to boost the return on your cash without putting your money into riskier options like stocks and even bonds. However, if you need the cash for an emergency fund, short-term goal, or something else, here are a few options:

• A checking or savings account: For short-term goals, a regular checking or savings account can work well. The point is to have easy access to the funds rather than to try and maximize a return for a short period of time.
• A high-yield savings account: For things like an emergency fund, a high-yield savings account can be a great option. You’ll earn more than in a checking or savings account, and the money is still readily available.
• Certificates of deposit (CDs): If you have a goal that is 6 or 12 months off, a CD could be a good option. These short-term savings vehicles generally offer a slightly higher interest rate than a high-yield savings account. Keep in mind CDs may come with an early withdrawal penalty, so you need to plan accordingly.
• Series I savings bonds: With inflation at a 40-year high, protecting your purchasing power is important. For goals that are at least 12 months away, purchasing series I bonds could be a good solution. Remember there are limits on how much you can purchase each year, and you cannot sell them for 12 months from the date of purchase.

Now that we’ve discussed how much cash to have for life today and current and short-term goals, let’s explore the role cash should play in your investment strategy.

What percentage of cash should be in my investment mix?

The amount of cash you have as part of your overall investment strategy will vary based on your time horizon, appetite, capacity for risk, and need to generate income from your investments. Generally speaking, the closer you are to retirement, the more cash you should have. 

Here’s how to think about cash at every stage of your investing life:

• Before you retire (more than 5 years to retirement): When you have a longer time horizon, cash is generally not needed as part of your investment strategy. Cash may be appropriate for reasons mentioned earlier, like your emergency fund or short-term savings goals, but it shouldn’t be a part of your investment strategy. Cash is a low-risk, low-return asset that can drag on your investments and mean your long-term returns are lower than you think.
• Before you retire (less than 5 years to retirement): As you approach retirement, it may make sense to start building a larger cash cushion to help support your transition to and through retirement. There are a lot of big decisions you will need to make, and having a little extra cash can give you peace of mind and greater flexibility.
• After you retire: Once you retire, you’ll want a larger cash cushion to cover ongoing expenses. In general, aiming for 12 to 24 months of expenses in cash is reasonable. The right amount of cash depends on many factors, including, but not limited to, your current lifestyle and monthly expenses, your family situation and other people you may be supporting, the source(s) and predictability of your retirement income, and the level of risk in your investment strategy.

Cash isn’t typically considered an investment like stocks or bonds, but it can play a critical role in supporting your investment strategy. However, too much cash means your investments may not be working as hard for you as they could be. Here’s what to do if you have too much cash on hand.

What do I do if I have too much cash on hand?

If you have been holding onto extra cash because you aren’t quite ready to invest it, now is the time to create a strategy to put the money to work for you. The right approach depends on many factors, but here are a few tips to get your excess cash off of the sidelines and back in the market working for you:

• Prepare mentally for investing - Price fluctuations, market volatility, and downturns are all part of the investment process. For some investors, this can create anxiety. Still, it’s important to remember that downturns happen, markets have always recovered, and long-term investors have historically been rewarded for staying the course.
• It isn’t all or nothing: If you aren’t ready to invest all of your money, try investing small amounts over time. It’s a strategy called dollar-cost-averaging (DCA). For example, if you have an extra $24,000 in cash, you could commit to investing $2,000 per month for a year instead of investing the full amount at one time.
• Split it between stocks and bonds (diversify): You can split your excess cash between stocks (which are typically riskier) and bonds (which are typically less risky). You’ll balance out the ups and downs of market volatility a bit and give yourself a more balanced portfolio.
• Make sure you have an ongoing strategy: Many people aren’t sure how to put their extra cash to work because they don’t have an overarching strategy for their finances, including investments. Developing a financial plan that includes investing ensures you’re not leaving money on the table by informing critical decisions about how much to invest, what account types to use, and how much risk to take.

The right approach to investing your excess cash comes down to having a clear understanding of why you are investing, what you should be investing in, and how to evolve that strategy over time as life, taxes, and the world around you change.

Final word

Proactively planning for your cash needs means you’ll be well protected from emergencies and unexpected expenses, ready to tackle short-term life and financial goals, and prepared to capitalize on any planned or unplanned opportunities. More importantly, an informed plan for cash will give you greater clarity on your entire financial picture and help you invest confidently.

A CFP® professional with Facet can help you determine how much cash is right for you, create an investment strategy for any excess cash, and develop an ongoing plan to make sure your money is working hard for you.