Are you thinking about holding about a few months’ worth of cash at a time to cover your living expenses? You might need to think twice. For many retirees, their spending habits are such that they should be holding relatively large amounts of cash so they don’t have to withdraw from other assets in their portfolios.
Retired people walk a tightrope, keeping sufficient funds in their pockets to cover any sudden expenses, but not so much that inflation siphons off their life savings. Nevertheless, some experts find many retirees maintain only a fragment of their optimal level of cash.
A lot of investors rely on the three-to-six-months rule. What many people fail to realize is that their needs change in retirement. Studies show that most people need a substantially larger cash reserve at this stage of life. This is especially true if they depend much on their investment accounts for a large chunk of their income.
We acknowledge why a lot of savers can be reluctant to hold more cash. Who wouldn’t be disinclined with the appallingly low yields on savings accounts as well as the certificates of deposit (CDs), right? It’s also understandable that some long-standing habits will be pretty hard to break.
With that being said, if you’re approaching or in retirement, it’s highly advisable to take another look at your cash levels. Though not always apparent, you will discover that there are actually a few advantages to maintaining a bigger reserve.
Invaluable Peace Of Mind
Some common qualms about retirement are beyond your control, like economic conditions. Nevertheless, any fears that can be eliminated should be, where possible, and taking out more cash is one way to do this.
Knowing that your immediate portfolio distributions are kept safe will give you a larger buffer of comfort. With sufficient reserves, it’s a lot easier to maintain a longer-term perspective should the markets take a downturn.
It also diversifies you away from the stock market, which has become more correlated (with other U.S. stocks) over the past twenty years.
Higher Returns Means Greater Overall Wealth
You might be surprised about this, since it seems counterintuitive. But a higher level of cash reserves can potentially result in greater overall returns. This is possible because it lets you maintain more risk in your remaining portfolio. Additionally, these anticipated higher returns may even offset the idle cash, thus creating far greater wealth in the long term.
Do you want to alleviate the effect of low yields? It’s highly recommended to maintain only a piece of this buffer in your savings accounts or money market funds. You may allocate your remaining cash into short-term yet high-grade bonds, CDs, and other somewhat fewer liquid assets, which may outpace rates in the money market.
You may be tempted to reach for further yielding in this particular portfolio sleeve. But never fall victim to it. You know that the investors during the Great Recession learned the hard way that the risk that comes with even just a small increase in yield can be significant or earth-shattering. You may want to gamble to earn a little bit more on your cash. But it’s not worth risking your portfolio’s sustainability. This is the part where you have to play it safe.
Some Issues With This Strategy
Making a reliable income stream is a lot harder now than it was in the past. Treasury yields back then were higher, and the life spans shorter. Earlier generations managed to retire free of trouble by making investments in long-standing government bonds and just lived off the interest.
Conditions today are more challenging. Rates on guaranteed investments are low. In fact, you’re lucky if you manage to reach 2.5 percent at all on one-year CDs nowadays. As a result, you must be willing to take on sound market risks. This way, you may beat inflation; otherwise, your standard of living could erode.
It’s also worth mentioning that the climbing life expectancies now compound the difficulty.
How To Analyze Your Plan
It can be difficult to actually figure out if holding more cash makes sense and what one’s overall asset allocation should be when in retirement.
Some people continue to hold a lot of their portfolio’s assets in stocks. Some even have 100% in stocks! That is usually a big mistake. They are reaching for more returns, but a bear market can destroy their plans and leave them struggling to make ends meet.
It is important to actually run retirement projections using a variety of asset classes and asset allocations. Hire a financial planner or use sophisticated financial planning software that allows you to run a variety of projections with different allocations.
Planning applications like WealthTrace allow consumer users to do this. By homing in on the most optimal asset allocation and cash reserves, you can help alleviate a lot of stress that comes with planning for retirement.
The Bottom Line
A key component of a solid retirement plan is maintaining optimal levels of cash. Have you examined your cash allocations recently? Current market volatility may compel you to take another look. Nobody wants to run out of money in retirement and having a sub-optimal allocation in your portfolio can lead to you not being able to meet your retirement goals.
It is imperative you have enough cash ready for spending so you’re not forced to withdraw from assets that might have gone down in a recent market slump.