A cash cushion, or emergency fund, serves as a foundational component to any well designed financial plan. But how much is too much cash? While a nice problem to have, “what to do with my cash” challenges many high earners and business owners. With inflation historically averaging close to 3%, unnecessarily holding excess cash becomes costly as the purchasing power of each dollar slowly erodes over time. Are there thresholds that signal when enough is enough? While your bank calling you with investment ideas may be a helpful tell, I want to provide guidelines that you can utilize to decide what’s right for you.
Associating your emergency fund with your typical monthly expenses proves a powerful approach in finding the right amount of cash to maintain. I encourage you to review your budget and determine the average amount you spend each month.
Now that you know your monthly figure, how much cash to maintain can be related to the amount of “months you have on hand”. For example, if you spend $5,000 per month, and have $20,000 in your savings account, we can say you have 4 months of cash on hand. Exactly how many months to keep aside will largely depend on your personal situation. The answer to two major questions will help guide the appropriate cash reserve for both your personal as well as business consideration.
Are other people dependent on your income?
When nobody else counts on your income, you have more flexibility with maintaining a lower cash cushion. If you lose your job or miss a sales quota, it’s a lot easier to “figure it out” when only looking out for one.
Whether it is your spouse, a child, a parent, or employees – when other people count on you the stakes are higher. Prepare to build a larger cushion to account for this responsibility.
How reliable is your compensation?
Compare two extremes: one of a tenured professor and the other a commission based salesperson. Where do you fit on the scale of income dependability? Is your industry declining or thriving?
Steady, recurring revenue typically provides more certainty of income. This added certainty allows for a lower cash reserve, whereas a highly variable income benefits from an additional cash cushion.
A practical emergency fund contains three to eighteen months of typical expenses. Answering the two primary questions will help determine where on that scale to target. No dependents/steady income – 3 months of reserves might suffice. Multiple dependents/variable income – 18 months may be more appropriate.
If you’ve now determined you are carrying too much cash, there is a final question to ask before making a change. “Will I be able to sleep at night?” If you are used to carrying a lot of cash, a dramatic reduction can be stressful. Don’t panic and force yourself to go from 10 to 4 months overnight. Move slowly, and ensure you feel comfortable with the change. And of course, if you’d benefit from a partner through the process, don’t hesitate to reach out!