The No. 1 Rule for How Much Cash You Should Keep in Retirement
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Cash is a valuable asset for retirees since it offers certainty at a time when you likely need to start tapping your savings, and you can earn interest on it with a high-yield savings account and other cash equivalents.
But if you keep too much cash, you risk falling behind inflation and missing out on potentially high returns in the stock market. That’s why many financial advisors recommend keeping one to two years of cash on hand in retirement, plus some money in bonds, certificates of deposit (CDs) and other low-risk investments.
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Why too much cash is risky
Your cash typically doesn’t earn high interest in a traditional savings account, and usually doesn’t earn anything in a checking account. A high-yield savings account can help, but real returns after accounting for inflation and taxes are much lower than the advertised rate. That’s why it’s essential to keep your money working for you.
While retirees likely aren’t looking for many new investing opportunities, they should still keep ample cash to cover their needs. This buffer can help prepare you for emergencies, and allow you to be less nervous about sharp market fluctuations since the stock market’s performance does not impact your ability to cover living expenses. It’s even easier to stay invested if you are receiving Social Security, dividends and other income sources that make the need to sell assets less likely.
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How much cash to keep
Many financial advisors recommend retirees keep at least enough money to cover a year of essential expenses, but that amount will look different for each person. Some retirees have enough cash to cover up to three years of expenses in liquid accounts. If you are more risk averse or want to travel a lot in retirement, you may want to save more. If you have a pension or other forms of income, you may not need to save as much.
Experts at T. Rowe Price recommend holding enough cash to cover one to two years of living expenses beyond predictable Social Security and pension income in addition to what you keep to cover daily needs such as gas and groceries.
What to do with the rest of your money
Having enough cash to cover up to 12 months of living expenses is a good start, but that doesn’t mean you should put all your remaining money into the stock market. A tiered bucket approach can ensure your cash reserves grow at a healthy pace while giving your stock portfolio more time to rally.
Short-term cash constitutes the funds that can cover up to one year of expenses, but there are medium-term assets like bonds that provide cash flow you can turn to. You can pick maturity dates that range from one to three years, so you are never locked out of those funds for too long. Money for long-term goals can still be invested in stocks, depending on your strategy.
While stocks are a popular choice, it may also make sense to invest in inflation hedges like gold and other commodities that can hold steady or gain value when stocks go down. Many experts suggest allocating 5% to 10% of your portfolio to gold.