Dear Ms. MoneyPeace:
How much should we hold in cash? Does the term cash only refer to money in a bank account? With incredibly low interest rates and such a good stock market, it's not clear how much to set aside. This is the question I ask myself as a married and retired person.
Already retired Annie
Your question is often asked by people of all ages. Even with low interest rates, security accounts – I don't like to call them emergency funds – are indispensable. Married, single, or in some form of partnership, you need fallback to meet basic needs.
How much this amount should be is personal and depends on your expenses and responsibilities. A rule of thumb is three times the cost of living, but if you own a home, move it closer to six months. This money should be kept in an account separate from your daily money and any savings for your next car, big trip or celebration. Savings are independent of the mix of stocks, bonds, and cash you have in your investment accounts.
If you are retired, you will still need a safety account. Even if you have a stable monthly retirement income or a payout strategy for your 401 (k) account, financial surprises can arise: think about a new oven or air conditioner, storm damage, condo reviews, car repairs, doctor and dentist bills.
Income from the stock market is not guaranteed. Ask retirees who lost the value of their investments in the dot-com crash of 2000 or the financial crisis of 2008 or March 2020. They may even have sold out of fear and permanently reduced their net worth when prices recover. These assets are difficult to replenish in retirement. Cash gives you time, clearer thinking, and allows you to stick with your long-term investment strategy.
Cash is an asset that you can access quickly and predictably. That is why we start with cash, be it in a savings account, a money market fund or a certificate of deposit. Check if the account is insured by the FDIC (money market accounts are not.) Don't let better interest rates sway you as these are only part of the story.
Of course, you can sell other assets – from your home to your car to jewelry, even stocks and bonds – for cash to make them liquid. But the dollar value is unpredictable. In some cases time is also involved. And don't forget the additional cost of capital gains taxes on investments and, in some cases, your home.
Read: This can save you money on capital gains tax when you sell your home
No matter when you need it, cash keeps the same price; Investments don't.
A home equity line of credit, or HELOC, is not a security account, although some claim. It's a backup option that's easy to get, but once tapped, it's a loan that must be paid back with interest. No matter how tempting the option is, you are taking a risk. Paying off debt is not easy in retirement, especially given inflation. And getting into even more debt when you stop working creates stress.
Withdrawing money from an investment account – whether it be 403 (b), 401 (k), or IRA – is smart with a plan. But without one, the effects wreak havoc financially. A retiree built her dream home and blown her budget. She withdrew $ 10,000 from her IRA to make the final payment to the contractor and get fixtures she wanted in a closet. However, she was only 59 years old. She had to pay an early withdrawal penalty of $ 1,000 – on top of the income tax due – (withdrawals from traditional retirement accounts are taxed as normal income). Deciding and acting in the blink of an eye cost her extra money.
Adding an extra monthly payment, paying an early withdrawal penalty, or selling assets in a hurry may not be a problem today, but retirement will take many years, hopefully decades. A stable cash fund can help you overcome those bumps along the way and give you a fun, more relaxed retirement.
CD Moriarty is a certified financial planner, MarketWatch columnist, and personal finance speaker. She blogs at MoneyPeace.
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