How much cash should we hold?

That is very timely question.  Putting cash in a high interest saving account can’t beat inflation still. However, we need to keep enough cash for emergency purpose. In retirement, the need for cash to cover living expense is even higher.  Therefore, it is important to maintain a fine balance of growth and security. In the long term, growth is the foundation for security too. We don’t want to outlive our savings.

Some retirees put all of their savings in GIC due to fear of market crash.  I am not for the 40/60 stock and bond portfolio mix because I feel it is arbitrary. I think the size of the portfolio is the key. If it is very small, one has to be extremely careful because the buffer is so limited. The split of stock/bond/cash should be able to withstand 7-year market downturn plus recovery. Why 7-year? The history shows the most recessions took fewer than 7 years for the market/S&P 500 index to recover back to the pre-recession high.  However, the two recession in the 20s and 30s took longer, so some prefers to prepare for 10-year bear market plus recovery rather than 7 if they have big enough portfolio. In then end, we want the blended annual return of our portfolios higher than 4% or more. Why 4%? See here for more about this magic number.

Use our annual living expense minus the retirement income from government/employer sources such as CPP (Canadian Pension Plan), OAS (old age security) and employer pensions. The remaining annual amount times 7 to 10 could be the total cash and bond amount in your portfolio.

For example, if you keep 1-year living expenses in cash or equivalent, then 6-year living expenses in bond.  Not any kind of bond, but government bond. Some recommend to split it into government short/mid/long bonds while some just put it all in government long bond.  

For those who are still working, here is the usual suggestion. When the market is down, we are supposed to deploy cash and buy securities. When the market is all time high, it might be a good idea to raise cash.  It is counter-intuitive to common sense of the non-investing world. Usually, we are told to save more for raining days. Below is an idea.  

Put 3-month living expenses in cash in high interest saving accounts as emergency fund. Maintain a well diversified portfolio that can cover 6-month living expenses in any economic condition in TFSA. For example, at least it has three types of securities. One to fight recession, one to benefit from inflation and the last one to provide secular growth. Each can cover 6-month living expense so that you don’t have to sell any securities at a loss when you need more than 3-month living expenses.

I know that certain people really don’t want to hold cash. They think that they can dip into the line of credit for emergency fund. You might need to consider how secure your job is. Are you disciplined and organized with money? Do you maintain a regular budget and track your expenses? If the answers are no, please be very careful with using line of credit for emergency fund especially giving the high interest rates now.

Published by Worthfy

Financial literacy and counselling

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